Monday, November 3, 2014

Run, run that I catch you: The Chilean economic lethargy

In 2008, in a speech to businessmen in Latin America, the Caribbean and the European Union, the President of Peru Alan Garcia said bluntly that "We admire and appreciate Chile, for their experience, their democratic consensus, for its growth, the only thing we say is that we want to win them, we want to be better ... " These words of President Garcia rocked the national pride and led Peru to become one of the most dynamic and fastest growing economies in the region. Peruvian authorities have taken advantage of the time, and in recent years have implemented major reforms that have boosted the economy of Peru to be an important focus for international investors. Opening with it great business opportunities for the country.

The reforms and the best business climate that has occurred in Peru have also occurred in other countries in the region, particularly in Colombia, who beat Argentina and become the third largest economy in Latin America, Mexico and Panama. And so, as the advantage that once had Chile, has faded, and the country now has to compete with others to be the best place to do business in Latin America. This was the main message delivered to us by the latest Doing Business 2015 report, where Chile reached the number 41 position, dropping from 34 ** position that it had in the previous report, Doing Business 2014. Until Doing Business 2014 Chile leaded the ranking in Latin America and the Caribbean, being followed by Peru (42), Colombia (43) and Mexico (53). But today Chile has been relegated to fourth place ranking among the countries of Latin America and the Caribbean. Colombia has taken the lead standing at position 34, followed by Peru (35) and Mexico (39). This is a good news for the region, and realizes that there are several countries that have endeavored to improve the business environment. But, beyond that which is good news for the region also accounts of a less every day brilliant performance that it's showing the Chilean economy since the return to democracy in 1990. With the exception of President Sebastian Piñera (2010- 2014), in all governments that succeeded the government of President Patricio Aylwin (1990-1994), the average economic growth rate has been lower every time.
Growth rate of the economy for political cycle (%)

Chile in the 1980s and 1990s, and the rest of Latin America in the past decade and this, had a period where structural reforms eliminate inefficiencies and distortions that had a simpler solution in terms of their architectural design, which allow for a much easier growth than today. These reforms, which were groundbreaking and very important, had a major impact on economic growth. However, since having corrected the problems of macroeconomic design and sectors macro design, the road is more complex to continue with high growth rates. The second generation reforms are less obvious and more complex since they aim to find a suitable fine tuning in the regulatory framework, institutional design, and to correct those market distortions that arise as countries develop. Being complex and point to the fine tuning of the model, is that the authorities should be extremely cautious in their proposals, and usually refoundational aspirations to change everything instead of understanding where defects are to be corrected, end in resounding failure. For Chile messianic visions to reestablish all are not new, and its consequences have been disastrous. Just looking at the recent past, we have the example of the Transantiago, a Michell Bachelet 2006 reform to restructure the public transportation system that ended as one of the biggest public policy disasters. The big challenge for Chile globally is how the country is more competitive, how its products have higher value added and are delivered in a more efficient way than other countries. The quest is to be more innovative, to improve the efficiency and competitiveness of the country, and is in these second generation reforms that the country has lagged behind. But with good reforms, it is also important to ensure the political and business environment, where entrepreneurs and investors do not feel in a way that their business, legitimate and essential for the development of the country, is subject to a permanent questioning and discrediting by different political and social players. It was thanks to the current model of development that Chile was able to access as a full member of the OECD.
José María Aznar on his recent visit to Chile has noted: “Investing in Chile is still safe, but before there was no doubt that now there are.” Aznar's opinion is not isolated, the Financial Times newspaper in an article on Latin America: The party is ending for Latina America, says "... Chile, often taken as a model sober economic management. But in just a year, the growth of its copper-dominated economy has slowed from almost 5 percent from a year ago to as little as 1.5 percent in the third quarter. Santiago´s political atmosphere has turned poisonous and Michelle Bachelet has seen her ratings slide after last year´s landslide electoral win. Which is complemented by another in the same medium by mid-October: Chile faces tougher sell to investors as growth stalls, noting "Chile perfectly captures the catchphrase from last week’s World Bank/International Monetary Fund meetings: the “new mediocre”. Seven months into the new administration of socialist president Michelle Bachelet, growth has stalled in Chile and inflation is pressing upward."
Although Chile is the country with the highest per capita income in the region, and leading in many indicators of social and economic development, is a small country, and its development opportunities are determined by how efficient is with respect to the global economy and what make the country attractive for foreign investment.
The tax reform that, among other things, increases corporate taxes from 20% to 25%, is expected to increase tax revenues by three percentage points of GDP in 2018, to finance an educational reform that gives no guarantee that the quality of education will improve. An article published this week in the Wall Street Journal: The Chile miracles "goes" in reverse, realizes the enormous risks involved in the educational reform promoted by the Government. While the major reforms of the present administration has not jettisoned the development model that allowed Chile to be a reference, they set doubts about their real benefits and the risks that they meant for economic growth.
Government revenues are approximately 20.8% of GDP, and the goal is to reach a figure close to 23.8% of GDP. If the impact of tax reform is to punish the growth rate by 2 percentage points (in 2013 the economy grew by about 4.5% and this year 2014 the figure would not exceed 2%), then the additional tax revenues that you would get in the short term, when the reform is implemented, does not compensate for the loss of economic growth and greater resources that by this way the Treasury would get. Thus, if the cost of the reform is of lower growth, the reform will make all poorer, the Treasury would get more as a percentage of GDP but a smaller amount of revenues; not only would the resources received by the Treasury may well be smaller but resources remain in the hands of other citizens and the economy will too. If the cost of the tax reform has been sacrificing growth, then the country has made a very bad deal.
OECD Corporate Tax Rate (%), May 2014
Since the return to democracy in 1990, with the exception of the period of President Sebastian Piñera (March 2010 - March 2014), the country's economic performance, as measured by its growth rate has a decreasing trend. Chile needs good reforms in the energy sector, education, health, pensions, and many others, and certainly the reforms that current administration has been pushing produce many doubts as noted José María Aznar.
With the recent Doing Business report Alan Garcia has much to celebrate, and this has been a great merit of the people and the governments of Peru, but also a large share of the responsibility of governments in Chile has been in a lethargy and for not delivering the good second generation reforms that the country needs to give a strong impetus to economic growth.
** 39th place if to the Doing Business 2014 data is applied the new methodology.

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