Debunking the ‘Free Market Miracle’: How industrial policy enabled Chile’s export diversification

Assessing industrial policies in Chile remains a rather contentious and divisive topic. Chile has long been held up as an almost‐textbook example of the success of ‘letting the market work’, as there was a broad agreement among mainstream economists that Chile has largely succeeded in promoting strong and stable growth because it has embraced free market policies. At first glance, this may seem believable.  Afterall, Chile has one of the fastest growth rates in Latin America since its neoliberal turn in the 1970s. Despite the continuing significance of copper, it has also managed to diversify into other sectors and acquire new competitive advantages between the 1960s and 1990s. The dominant view sustains that the successful emergence of new competitive sectors in Chile’s export basket are the result of four decades of commitment to liberalization and free market policies. However, this post, which is based a recent study, shows that Chile’s export diversification was not the result of free market policies, but of carefully crafted government interventions. The idea of Chile as a ‘free-market miracle’, as first described by Milton Friedman, is therefore one of the most enduring myths associated with recent economic development history.

Chile has managed to diversify by doing much more than laissez-faire and leaving the steering wheel to the market’s invisible hand.

Chile is often viewed by admirers and critics alike as the quintessential neoliberal model of development in Latin America as it was the first country in the region to embrace neoliberalism after the 1973 coup against Allende’s socialist government. Nevertheless, while the Pinochet administration was explicit in stating that the government avoided picking winners by ‘letting the market choose’ (thereby invoking the logic of the Chicago School), it was also discreetly -yet heavily- involved in subsidizing the structural transformation of the Chilean economy, by intervening in almost all the major sectors that eventually emerged in Chile’s export basket since the 1970s (namely the salmon, fruit, forestry, and wine sectors as shown in figure 1).

Figure 1: Composition of Chile’s Export Basket in 2017.

Source: UN COMTRADE (2019)

Figure 2 highlights the vertical policies that belied this claim of sector neutrality and the role played by various types of public institutions (including government agencies, the Central Bank, and universities) in the process of capability accumulation and in overcoming market failures inhibiting the emergence of new industries.

Figure 2. Mapping the policy interventions underlying the emergence of new sectors in Chile’s export basket.

In contrast to the widespread laissez‐faire narrative, industrial policies were used to effectively govern the market by sending market signals towards new areas where private entrepreneurship had been suboptimal. The role of the Chilean state was essential in catalysing human capital accumulation, ensuring ‘national’ sector reputation through a strong regulatory and quality control, providing semi-public venture capitalism, and diffusing expertise and technology in non‐copper related sectors through various public institutions. Interventions even included the provision of subsidized credits through the Central Bank and CORFO (especially in the forestry and fruit sectors). The opening up of the economy in the 1980s later took advantage of the specialized human capital, knowledge and technological capabilities accumulated through vertical interventions prior to liberalization. While it can be argued that some sectors such as the wine industry could have developed through market forces alone, it is undeniable that other sectors would not have developed to the same extent without vertical interventions (in fact, it is likely that some would not have developed at all, given the policy‐induced endowments for the forestry and salmon sectors). The comparative advantage that Chile developed in salmon, forestry and fruit production did not simply rely on natural factors; rather, it has mostly been acquired through technology upgrading, human capital accumulation, export quality control and financial incentives, through state interventions. In addition, while the wine sector’s technological upgrading was mostly the result of foreign investments and horizontal policies (unlike the other sectors), it is worth noting that those foreign investments targeted an industry in which Chile was already operating, and therefore did not promote a new product beyond Chile’s pre-existing productive structures.

Furthermore, in contrast to the sectors that relied on state interventions, value addition has been relatively weak in the sectors where the state has adopted a more laissez faire approach, such as the copper sector. Another recent study found that the industrial fabric around Chile’s copper is rather weak in comparison to those found in other resource-rich countries such as Australia and Malaysia, where industrial policies were heavily used to promote both downstream and upstream value addition.

Nevertheless, it would be misleading to think that industrial policy was a consistent feature of Pinochet’s economic policy. The regime’s shock therapy in the mid‐1970s (which included the elimination of price controls, cutting public expenditures by half, privatization of several hundred state‐owned firms, and drastic reduction of import tariffs) sent the country spiralling into a financial crisis within a few years, and led to a steep increase in non‐traditional imports but also a drop in the imports of equipment and machinery, which was insufficient to raise productive investment and recover the growth rates of the 1960s. Free-market policies had also resulted in the financial and balance of payment crisis before the 1982 debt crisis, which may explain why the military regime increasingly relied on industrial policies thereafter.

The abandonment of industrial policies contributed to export concentration and commodity dependence in Chile.

While some of the most successful vertical policy instruments were used during the seemingly economically liberal military regime (1973-1990), the progressive abandonment of those policy tools since the 1990s is correlated to country’s decreasing degree of export diversification.

Figure 3: Evolution of the IMF Export Diversification Index for Chile (1964–2010).

Source: IMF (2018)

Since 1990, the new political economy has been rooted in neoliberal fundamentals, with a policy consensus that economic growth is based on ensuring macroeconomic stability (low inflation, low fiscal deficits, and moderate current account deficits) and an underlying view that industrial policy is unnecessary or unproductive. Economic policy has also focused on natural comparative advantages, which attribute more importance to natural resource endowment than the potential for capabilities accumulation, learning by doing and incremental innovation in new industrial sectors. While focusing on sectors strictly related to resource endowment is sensible, it should not prevent strategic gambles beyond a country’s comparative advantage. While it is true that Chile has been one of Latin America’s fastest‐growing economies in recent decades, we must acknowledge that such growth since 1990 has owed much to high copper prices. Indeed, Chile’s growth slowed since 2014. In the 2014-2019 period, Chile’s average GDP growth dropped below 2.0% (even reaching even 1.0% in 2019), ranking it only 17th amongst 33 Latin American and Caribbean economies.

The fact that Chile’s recent export concentration has eventually translated into slower economic growth shows that “adhering strictly to macroeconomic fundamentals is not enough to ensure steady high-end economic growth when sector-specific weaknesses are not addressed”. In that perspective, several Chilean economists (such as Manuel Agosin, José Miguel Ahumada, Claudio Bravo-Ortega, Ricardo Ffrench-Davis, Nicolas Grau, Gabriel Palma, Andres Solimano, amongst others) have produced seminal works that critically analyzed the role of state interventions and the limits of the neoliberal model in Chile.

Why it matters in the context of today’s quest for a more inclusive economic model in Chile.

“Less Friedman, more Keynes”. Banner during the 2011–2013 protests in Chile. Credits: The Chicago Boys (2015)

Over the past decade, Chile has been shaken by waves of social unrest, which culminated with the 2019 protests. Such protests were motivated by the perception of growing inequality and have generated considerable political and economic instability. Chile’s unequal distribution of income is also intrinsically related to the growing concentration of its productive structures.

A new model is therefore urgently needed to diversify the Chilean economy, create jobs, and reduce inequalities in the country. Such model requires the return of industrial policy at the forefront of the policy agenda. Improving the pre-distribution of income would indeed require a coordination between social, education but also industrial policies to generate the demand for those workers and their newly acquired skills.

Industrial policies will also be needed to make the most of lithium resources as a tool for productive development. Some of the mistakes from the copper sector and limited state interventions to promote value addition should be avoided as lithium provides an opportunity for Chile to get ahead in the technological race.

The current quest for a different development model in Chile represents an opportunity to rethink the role of state interventions. As we can learn from the East Asian Miracle, but also from Chile’s very own history, several elements (such as targeted human capital accumulation, technological diffusion, R&D support and environmental sustainability) that are crucial for the acquisition of new comparative advantages, are difficult to manage without policy interventions. Debunking the myth of Chile’s neoliberal solutions therefore not only matters for building a more nuanced narrative of Chile’s past economic development but also has high relevance for its future trajectory.

Amir Lebdioui is a Research Fellow at the London School of Economics. He tweets at @amirlbd.

This post is based on the following study: Lebdioui, Amir. (2019) “Export Diversification in Chile since 1960: a free market miracle or a free market mirage?” Development and Change, 50(6). Accessible in full here.

Headline photo: Palacio de la Moneda in Santiago de Chile.

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