In 1991, the former finance minister of Chile, Alejandro Foxley, said in an interview: “We may not like the government that came before us. But they did many things right. We have inherited an economy that is an asset.”
About twenty years before, General Augusto Pinochet had toppled the democratically elected President of Chile, Salvador Allende. Pinochet’s rule from 1973 to 1990 was characterized by severe violations of human rights, yet finally he agreed to hold a referendum on his political future, and when the Chilean people voted against him, he stepped down without bloodshed or violence.
SEEDING REFORMS
Of what kind were Chile’s acclaimed economic policies? Pinochet relied on a group of Chicago-trained economists (nicknamed “Chicago Boys”) who, as Karen L. Remmer writes in the Journal of Developing Areas, “removed free market restrictions” and “dismantled the state sector of the economy in favor of private ownership”. Between 1973 and 1976, spending of the Chilean government fell by 40%, and 449 state-owned firms (out of 494) were privatized, while the government share in the labor force went down from 18% to 13%. In the agricultural sector, the Chicago Boys abolished existing restrictions on landholding size and land ownership. Previously one of the most protected economies in the world, Chile almost entirely erased protective tariffs, to “promote the modernization of Chilean industry, subject monopolies to foreign competition, and encourage a more efficient and rational allocation of economic resources” (Remmer). With regard to foreign investments, the government got rid of bureaucracy and lifted various restrictions for foreign investors. The goal was to make Chile, as it was officially announced, “the best place in Latin America to invest”. Government agencies, like the financial markets supervisory authority, were dissolved. Labor laws, restricting the layoffs of workers, were weakened, and social welfare expenditures and minimum wages were reduced. Remmer writes: “The theory of economic development guiding these policies was that… future economic progress would depend on the expansion of industries able to compete on the international market”.
The immediate consequences of this shock therapy were double-edged. The inflation rate fell from 505 percent in 1974 to 30 percent in 1978, and the balance of payment improved: in 1976, Chile achieved a trade surplus of $500 million. Not unexpectedly, however, inequality rose as well: it is estimated that the top 5% of income recipients increased their share of the national product from 23% to 50%. And the reforms were pushed against the fierce resistance of large parts of the population. As Pablo Baraona, the governor of the Chilean Central Bank, said at the time: “The fact that more than 90% of the people are against our policies is proof that the model is working, that it has affected everybody and that it has privileged nobody”.
Does the Chilean economic agenda seem familiar to you?
HARVESTING SUCCESS
As it is usually the case with economic reforms, their fruits can only be harvested much later, often by the successors of those who implemented them. While in Chile of the 1970’s, there was a lot of turmoil and social hardship, the situation stabilized in the 1980’s. The greatest dividends, however, were incurred in the 1990’s and later. Between 1990 and 1993, Chile experienced an average growth rate of 7.7%, and from 1994 to 1999, this number was still as high as 5.6%. Between 1973 and 1999, exports grew by a staggering 9% per year. And the impact lasts until today: in the 2015 Index of Economic Freedom, published by the Fraser Institute, Chile's economy is ranked 7th (Georgia is 22nd). With almost $25,000 per capita income (PPP), Chile is the richest country of South America (Georgia: $9,500). Finally, in 2010, the international community acknowledged Chile’s economic success story when it became the only South American country so far to be admitted to the OECD, the “rich man’s club of developed countries” (Karen Kornbluh).
When Pinochet died in 2006, an editorial in the Washington Post summarized his legacy as follows: “Mr. Pinochet was brutal: More than 3,000 people were killed by his government and tens of thousands tortured, mostly in his first three years. Thousands of others spent years in exile. It's hard not to notice, however, that the evil dictator leaves behind the most successful country in Latin America. In the past 15 years, Chile's economy has grown at twice the regional average, and its poverty rate has been halved. It's leaving behind the developing world, where all of its neighbors remain mired.”
DON’T CHANGE A WINNING CONCEPT
Returning to Georgia, there is no doubt that the government of Georgian Dream can claim a great achievement, namely ending the notorious practices of extortions and political blackmail which had become the unjustifiable epitome of the late Saakashvili era. In 2012, an increasingly authoritarian government was replaced by a more civilized one (like in Chile, without violence, a fact for which one cannot praise Pinochet and Saakashvili too much). However, there is an important difference between Chile and Georgia: the subsequent governments of Chile were careful not to reverse the successful economic policies that were enacted under the previous government. As Robert Packenham and William Ratliff write for the Hoover Institution: “All four civilian governments [of Chile] since 1990 have maintained the new, more market-oriented economic and social models inherited from the military regime. Although there were changes at the margins after 1990, the point of sharpest and deepest positive change was unquestionably 1973 and immediately thereafter, not 1970 or 1990.”
The Georgian government, on the other hand, puts at stake those libertarian economic principles for which Georgia had gained international reputation between 2004 and 2012. By adopting policies of excessive government interventions, be it through the reinstatement of a competition authority, the announced antidumping law, or the anti-dollarization measures recently promulgated as a response to the lari devaluation, Georgia may quickly forfeit its economic advantages. As one can learn in an advanced microeconomics class, a government must only tinker with the free market if there is market failure. Without market failure, government interventions can only make a bad situation worse. Economic theory is very elaborate on this, and there is no place for reasonable doubt on this matter. Dollarization, however, is no market failure but the optimal adjustment of economic agents to a situation of economic uncertainties. The government should abstain from interfering.
Clearly, there are many economists endorsing the government’s interventionist plans, but one should realize that many of the countries sending and paying these experts have in the last 13 years not been economically as successful as Georgia. Many European nations, for example, did not experience satisfactory growth for decades, suffering from the very structural problems caused by the interventionist recipes they want to prescribe to Georgia.
If the government wants to stabilize the lari’s value in the long run, there is no alternative but to build trust in Georgia’s economy. This trust will be primarily established by reducing the government’s involvement in economic matters, as demonstrated between 2004 and 2008, when the price of the dollar fell from 2.20 GEL to 1.40 GEL. This long-term appreciation of the lari was interrupted by temporary devaluations, and it is important to understand that these are totally inevitable for a very small economy exposed to the forces of international foreign exchange markets. Instead of economically detrimental responses to something that cannot be controlled, the government must concentrate on the long run – building trust, letting the market work, and interfering only in clear-cut cases of market failure. Cushioning social hardship in a limited way may be part of the program. Most important, however, is that there will be no tinkering with the Liberty Act.
The current government is making very promising efforts to move Georgia towards true judicial independence. That would be a lasting contribution to the building of a sustainable Georgian state, particularly in view of the growing dangers stemming from the geopolitical dynamics here. Indeed, like in Chile, there are many points where the Georgian Dream government can (and did) improve on its predecessor. The economic principles that guided Saakashvili’s reign, however, are not one of those.
For the sake of successful state building, this needs urgent remedy. It will strengthen Georgian Dream’s legacy, without any doubt!
Florian Biermann is assistant professor of economics at ISET, where he teaches, among others, a course in market failure.
Kálmán Mizsei is former visiting professor at the Central European University in Budapest, Hungary. He served as regional director of UNDP for Europe and the CIS, Special Representative of the EU in Moldova, and head of the EU advisory mission to Ukraine. Currently, he is writing a study on transformation processes in Eastern Europe.
Comments
Why do we need a bloody and corrupt dictator to teach us the virtues of liberalizing Georgia’s foreign trade or not meddling with its exchange rate? If anything, using Pinochets name to promote liberal ideals or policy solutions is terrible PR for these ideals and policies.
The Chilean experience is mainly relevant for Georgia because of the way the Chileans dealt with the legacy of an evil regime. The current Georgian government is making many economic mistakes based on the desire to reverse Saakashvilis policies. Many such reversals are justified, but there is no reason to roll back the highly succesful economic setup of Georgia. The GD government now follows the policies of economically dysfunctional European countries.
Besides that, Pinochet is vilified too much. Let me compare Pinochet with Castro (this comparison was featured in one of the articles we cite):
__ 3,000 murders can be attributed to Pinochets regime (http://news.bbc.co.uk/2/hi/americas/country_profiles/1222764.stm), while to Fidel Castros regime can be attributed 10,753 (https://www.aei.org/publication/counting-victims-of-the-castro-regime-nearly-11000-to-date/). Fidel Castro murdered three times more people than Augusto Pinochet.
__ Pinochet peacefully stepped down when he lost a referendum. Castro never stepped down, with his brother torturing Cuba with policies in the spirit of Fidel Castro to this day.
__ Pinochet handed over to his democratic followers a well-functioning economy. Castro has not handed over yet, but the Cuban economy is a complete mess.
Despite this devastating record, Fidel Castro receives all kind of praise from the political left, while they vilify Augusto Pinochet. Nothing against vilification of Pinochet, and I do not justify the authoritarian measures taken by Pinochet, but the same vilification should be applied to Cuba. We are far from there. Jean-Claude Juncker, for example, issued the following statement when Castro died: Fidel Castro was one of the historic figures of the past century and the embodiment of the Cuban Revolution. With the death of Fidel Castro, the world has lost a man who was a hero for many. He changed the course of his country and his influence reached far beyond. Fidel Castro remains one of the revolutionary figures of the 20th century. His legacy will be judged by history. I convey my condolences to the Cuban President Raúl Castro and his family and to the people of Cuba.
The internet is full of critical accounts about the economic (and not only) aspects of Pinochets regime, including by Chileans and people who seem to have studied the Chilean miracle. Here is an excerpt from one that takes a particularly critical view:
The claim that General Pinochet begat an economic powerhouse was one of those utterances whose truth rested entirely on its repetition.
Chile could boast some economic success. But that was the work of Salvador Allende _ who saved his nation, miraculously, a decade after his death.
In 1973, the year General Pinochet brutally seized the government, Chiles unemployment rate was 4.3%. In 1983, after ten years of free _ market modernization, unemployment reached 22%. Real wages declined by 40% under military rule.
In 1970, 20% of Chiles population lived in poverty. By 1990, the year Pinochet left office, the number of destitute had doubled to 40%. Quite a miracle.
Pinochet did not destroy Chiles economy all alone. It took nine years of hard work by the most brilliant minds in world academia, a gaggle of Milton Friedmans trainees, the Chicago Boys. Under the spell of their theories, the General abolished the minimum wage, outlawed trade union bargaining rights, privatized the pension system, abolished all taxes on wealth and on business profits, slashed public employment, privatized 212 state industries and 66 banks and ran a fiscal surplus.
Freed of the dead hand of bureaucracy, taxes and union rules, the country took a giant leap forward _ into bankruptcy and depression. After nine years of economics Chicago style, Chiles industry keeled over and died. In 1982 and 1983, GDP dropped 19%. The free _ market experiment was kaput, the test tubes shattered. Blood and glass littered the laboratory floor. Yet, with remarkable chutzpah, the mad scientists of Chicago declared success. In the US, President Ronald Reagans State Department issued a report concluding, Chile is a casebook study in sound economic management. Milton Friedman himself coined the phrase, The Miracle of Chile. Friedmans sidekick, economist Art Laffer, preened that Pinochets Chile was, a showcase of what supply _ side economics can do.
It certainly was. More exactly, Chile was a showcase of de _ regulation gone berserk.
The Chicago Boys persuaded the junta that removing restrictions on the nations banks would free them to attract foreign capital to fund industrial expansion.
Pinochet sold off the state banks _ at a 40% discount from book value _ and they quickly fell into the hands of two conglomerate empires controlled by speculators Javier Vial and Manuel Cruzat. From their captive banks, Vial and Cruzat siphoned cash to buy up manufacturers _ then leveraged these assets with loans from foreign investors panting to get their piece of the state giveaways.
The banks reserves filled with hollow securities from connected enterprises. Pinochet let the good times roll for the speculators. He was persuaded that Governments should not hinder the logic of the market.
By 1982, the pyramid finance game was up. The Vial and Cruzat Grupos defaulted. Industry shut down, private pensions were worthless, the currency swooned. Riots and strikes by a population too hungry and desperate to fear bullets forced Pinochet to reverse course. He booted his beloved Chicago experimentalists. Reluctantly, the General restored the minimum wage and unions collective bargaining rights. Pinochet, who had previously decimated government ranks, authorized a program to create 500,000 jobs. In other words, Chile was pulled from depression by dull old Keynesian remedies, all Franklin Roosevelt, zero Reagan or Thatcher. New Deal tactics rescued Chile from the Panic of 1983, but the nations long _ term recovery and growth since then is the result of _ cover the childrens ears _ a large dose of socialism.
To save the nations pension system, Pinochet nationalized banks and industry on a scale unimagined by Communist Allende. The General expropriated at will, offering little or no compensation. While most of these businesses were eventually re _ privatized, the state retained ownership of one industry: copper.
For nearly a century, copper has meant Chile and Chile copper. University of Montana metals expert Dr. Janet Finn notes, Its absurd to describe a nation as a miracle of free enterprise when the engine of the economy remains in government hands. Copper has provided 30% to 70% of the nations export earnings. This is the hard currency which has built todays Chile, the proceeds from the mines seized from Anaconda and Kennecott in 1973 _ Allendes posthumous gift to his nation.
Agribusiness is the second locomotive of Chiles economic growth. This also is a legacy of the Allende years. According to Professor Arturo Vasquez of Georgetown University, Washington DC, Allendes land reform, the break _ up of feudal estates (which Pinochet could not fully reverse), created a new class of productive tiller _ owners, along with corporate and cooperative operators, who now bring in a stream of export earnings to rival copper. In order to have an economic miracle, says Dr. Vasquez, maybe you need a socialist government first to commit agrarian reform.
So there we have it. Keynes and Marx, not Friedman, saved Chile.
But the myth of the free _ market Miracle persists because it serves a quasi _ religious function. Within the faith of the Reaganauts and Thatcherites, Chile provides the necessary genesis fable, the ersatz Eden from which laissez _ faire dogma sprang successful and shining
Of course, it is a highly ideological topic and there is no proof that the Chicago Boys account for Chiles favorable economic situation. It is also not possible to prove the opposite. The fact that the best times started in 1983, when the purist libertarian approach was replaced by more moderate economic policies, does also not show anything. In most cases, economic reforms take many years to bring positive results (I could mention various examples here).
There is no proof for anything, but there is plausible evidence that government involvement is detrimental to development and economic growth. Even the best performing European countries have lower growth rates than the US for decades. In my opinion, the reason for this difference is the bigger role of the governments in Europe.
I shared this article with a Hebrew University classmate of mine, currently an economics professor in Chile. This is what he wrote in response:
This is outrageous and offensive for Chileans like me. It is so inaccurate that I wont even begin to refute it. Do they want me to make a list of good policies implemented under the Soviet regime? The list is long. Do they think the Nazis did everything wrong? Think again. This article is a political statement in defense of implementing ultra liberal economic reforms at any cost.
To your classmate, I can only say what I wrote above: compared with Fidel Castro, Pinochet has a rather positive record. I do not know your classmate, so maybe he vilifies both Castro and Pinochet equally, in which case his viewpoint is consistent.
However, your classmate does not say where the article is incorrect, so it is impossible to argue with him.
But the myth of the free - market Miracle persists because it serves a quasi _ religious function. Within the faith of the Reaganauts and Thatcherites, Chile provides the necessary genesis fable, the ersatz Eden from which laissez - faire dogma sprang successful and shining
Highlighting the merits of Pinochets economic policies is in progressive circles akin to praising Soviet Russias legalization of abortion in Catholic circles - a taboo subject. Without getting into the relative merits and demerits of Pinochets record it is relevant to remember that free-market policies in the 1970s and 1980s could only have been implemented in an authoritarian country: Democratic systems are usually very reluctant to experiment, especially when experimentation is the brainchild of academics rather than coming from the crowds. Independently of ones economic and political orientation it remains a fact that during the last 20 years many progressive governments have applied the policies of cutting taxes, privatising state-owned companies and deregulating trade, the job market and bureaucracy with Pinochet pioneered in Chile. No one can accuse Bill Clinton, Francois Hollande or Matteo Renzi of being right-wing extremists. The fact they were willing to learn the right lessons to be learnt from Chiles economic history suggests that Pinochets economic policies taught the world a few useful lessons.