On October 5, 1988, the Chilean people participated in an important
plebiscite to determine the future of the country's political system. The
issue was whether to provide General Augusto Pinochet with the mandate to
serve eight more years as president of Chile. The answer, by a vote of
54%, was no. The historic vote set the stage for Chile's first
presidential election since 1970. This transition was closely watched as
Chile was the last major Latin American country to return to democratic
rule. However, it is not only the political dynamics that have made Chile
such a popular country of study, but also the country's economic progress
over the past dozen years. Between 1986 and 1997, GDP grew by an average
of 7.6 percent, a figure which masks years in which growth approached 10%.
This accomplishment coupled with steadily decreasing inflation, an
unemployment rate which has been well below 10% since 1985, and improvents
in social indicators such as rising education and sanitation levels have
prompted many to hail Chile as a model for developing countries to emulate.
These achievements certainly deserve further examination. Clearly other
Latin American countries such as Brazil, Mexico, Argentina, and Peru have
not enjoyed this degree of success. This paper, in an admittedly short
space, will seek to review some of the issues and growing pains surrounding
Chile's much touted accomplishments from an economic and political
perspective. It will especially focus on context of financial
liberalization in the banking sector.
Government & Politics
The watershed event in Chilean political history, undoubtedly occurred on
September 11, 1973. On this day, the world's first democratically elected
Marxist President, Salvador Allende, was overthrown in a military coup.
Allende was in a weak position from the beginning of his term in 1970.
Elected with less than 40% of the vote, he sought to implement a "radical
nationalist and socialist" economic platform. The scene quickly turned
ugly. In an effort to secure a legislative majority through congressional
elections, Allende nationalized companies, instituted price controls, and
raised wages. When his gambit failed, Chile was left in a crisis state.
Inflation was rampant, it was suffering from severe balance of payment
problems, and the political process was paralyzed. The result, increased
calls for military intervention from opposition groups, and an ambivalence
by others because of the rapidly deteriorating economic situation.
General Pinochet, who led the coup, began as a first among equals in the
military junta, but moved quickly to make himself president. Pinochet
consolidated the government's control by banning political activities, and
moving to crush leftist organizations, including labor groups. The country
was placed under a state of emergency which was virtually renewed every six
months into the 1980s. The more centrist political groups, which had
supported the coup, soon realized that Pinochet planned to stay in power
much longer than they had expected and thus moved into the 'illegal'
opposition camp.
The regime enjoyed increasing support after 1976 as Chile witnessed rapid
economic growth, and in 1980 Pinochet ushered in a new Constitution which
set up the terms for a return to democracy. Although toleration for
political activities increased during this period, opposition parties
refused to recognize the Constitution as valid. The economic expansion
could not be sustained, however, and with GDP growth contracting by 12
percent in 1982, Pinochet faced a period in which his lock on power was
tested. Street protests against the dictator and his liberal economic
policies (which were blamed for the country's ills) were widespread, as
were calls for an immediate return to democracy. In 1985, a group of 11
political parties from across the spectrum signed a "National Accord"
pressing for "an immediate lifting of the state of emergency, a full
amnesty for exiles, a plebiscite to reform the constitution, and direct
presidential elections." During this period of unrest, Pinochet did grant
a few minor concessions to try and quell the turbulence such as rolling
back some economic reforms, temporarily lifting the state of siege, and
bringing civilians into his cabinet. However, the years 1983-1985 also
witnessed a dramatic increase in repressive tactics by the regime, and
Pinochet's unwillingness to budge on the time line for a return to
democracy ultimately meant that the protestors did not carry the day.
The 1980 Constitution called for a plebiscite to be held in 1988 in which
the military would put forward a choice for president (Pinochet), and only
if the voters rejected this "candidate" would elections be held. In 1987,
the economy was again growing, and many assumed that Pinochet would win the
plebiscite. Most of the now legal political parties still refused to
recognize the 1980 Constitution, thereby shunning official recognition and
refusing to encourage members to register to vote. This, however, would
rapidly change. In mid-1987, the centrist Christian Democratic Party
(PDC), the country's largest, replaced its leftist leader with one who
identified more with the conservative wing (Patricio Alywin). At the same
time, it abandoned its long-standing policy of refusing to recognize the
Constitution and instead pushed for a "no" vote in the plebiscite. Several
left-oriented parties followed suit. The strategy worked, and the
Concertación was born. The Concertación, an alliance of several political
parties ranging from the center to the far left, easily won the 1989
presidential election with Alywin as its candidate (and won again in 1993
with Eduardo Frei). Pinochet, however, did not disappear. After stepping
down as president he became head of the armed forces until early 1998 after
which time he took his seat in the upper house of the legislature as
Senator for life.
Chile's transition back to democracy has been rather interesting in the
Latin America context in a few important respects. First, there was no
economic crisis. This is very much unlike the rest of South America in
which severe economic problems forced the military regimes to return to
civilian rule. Second, was the ability of rather fractionalized left wing
parties to come together under in a more or less cohesive fashion under a
centrist banner, and to continue many of the economic policies of the
Pinochet regime. The timing is quite important, because had Pinochet been
toppled in the early 1980s it is extremely unlikely that the free market
orientation of the economy would have continued. Instead, Pinochet was
going out on a high note, so to speak, and even though it was an
"opposition" party that took power, the regime was able to excercise a high
degree of control over the transition process.
It will be interesting to see what affects, if any, the recent arrest of
Pinochet will have on civilian-military relations. It is likely that many
members of the Concertación are secretly filled with glee at the prospect
of Pinochet permanently incarcerated in a Spanish jail. So far, however,
the army, under the new leadership of General Ricardo Izurieta, has taken a
low profile letting the politicians handle the issue. Concertación members
will need to at least appear to be diligently working toward securing
Pinochet's release, lest they raise the military's ire.
Pinochet or no Pinochet, it would be surprising if any military posturing
seriously affected the Concertación's ability to govern. However,
dissension within the party itself could. As a coalition government, the
alliance is made up of parties with ideological differences. The PDC, the
most important group, is the party from which both Alywin and Frei hail.
Now, with the next presidential election to be held in December 1999, other
parties want a turn. Leading some national polls with a 42% approval
rating (his closest rival has 8%), is Ricardo Lagos, Frei's former
transport minister, who comes from the more left leaning Partido por la
Democratica (PPD). Presently, it is unclear whether Christian Democrats
would risk breaking the Concertación to push their own candidate, but some
of its members have already made their preference known for another CDP
candidate to run. Chile's right wing parties would like nothing more than
to see splits in the Concertación's coalition. No matter how this internal
battle plays out, however, one thing that will not be seen is the seemingly
en vogue manuever to amend the constitution allowing for second or even
third terms in office, such as in Brazil, Argentina, and Peru. The rules
of the game, even though sometimes unevenly administered under Pinochet,
seem to be rather well respected.
Finance, Business, and Economics Before 1990
In addition to "saving the country from communism," Pinochet is also
generally credited with steering Chile into the global economy through
liberal economic policies. Thus, the 1973 coup had a profound impact on
Chile's future economic direction and the role of the private sector. This
road, however, has always been an easy one, and it is probably useful to
begin any examination before the coup.
Economic power in Chile, as in many Latin American countries, has been
highly concentrated. However, it was not just a landed oligarchy which
controlled the wealth, but also an important business elite. In 1959, just
4% of the stock companies controlled about 60 percent of the circulating
capital. These large conglomerates (groupos) that controlled Chile's
industrial enterprises were financially interrelated and interdependent,
and at their centers were banks which had direct ties with these mega firms
through interlocking directorates and/or kinship relations. Once elected,
Allende attempted to wrest control away from this elite class by
nationalizing or intervening in the banking institutions and companies.
After a bit of hesitation, Chile's business elites were galvanized into
action. Several members of the larger conglomerates even formed the
"Monday Club" which outlined plans to destabilize the regime, including
channeling money into opposition parties, using its newspapers to mobilize
the middle class against Allende, and meeting with military conspirators.
Upon Pinochet's ascendance to power most of these firms were returned to
their original owners and a new era of radical neoliberalism began. One
exception that cannot go unmentioned, is that Pinochet did not return the
copper companies to private hands. State control over Chile's leading
export product served instead to provide the government with an important
source of foreign exchange.
Pinochet's economic policy team firmly believed that the market could
allocate resources more efficiently than the government. The Chicago Boys,
as the team was known, had a virtual monopoly on all key economic posts, at
one point heading the ministries of finance, planning and the treasury, the
budget office, and the central bank. The team's first goal was to reign in
inflation. Price controls were removed, subsidies were largely eliminated,
the state employment roles were slashed, and import tariffs were lowered.
The timing of these measures could not have been worse as they coincided
with first oil shock and falling copper prices. The cumulative effects were
painful with GDP shrinking by nearly 13 percent and unemployment almost
reaching 30 percent.
By 1976, however, the picture began to improve. GDP grew by an average of
more than 7 percent through 1981, inflation was falling and a middle class
began to emerge, bolstered by an overvalued peso. Pinochet was quick to
capitalize on the advantages that this s mini-boom provided. In 1979, he
implemented his Labor Plan. The policies served to keep labor weak by
banning confederations, forbidding unions from requiring members to pay
dues and making it optional for companies to collectively bargain with
unions that represent workers in more than one firm. It further encouraged
competition among unions and placed a 60-day limit on strikes.
Unfortunately, the "miracle," as some came to call Chile's growth, could
not be sustained. There seem to be several reasons for this. First, the
policy choices made by the Chicago Boys did not do much to stimulate
investment in productive enterprises. Instead, they encouraged more
speculative activities in the areas of real estate and financial
intermediation. For example, the overvalued peso fostered a consumption
boom with the current account deficit rising from $1.8 billion in 1980 to
$4.8 billion in 1981. Second, Chile's economic structure never really
changed from pre-Allende. In other words, the concentration over economic
resources mentioned earlier still existed, and perhaps became even worse.
For instance, between 1974 and 1978 the two biggest conglomerates
controlled more than one-third of the assets of Chile's 250 largest firms.
By the end of 1977, these same two firms also held 40 percent of the
private sector banking assets and nearly 30 percent of the financiera credit.
Finally, the way in which the economic policy decision makers were
structured, and perhaps even selected, was flawed. The policy makers
reported directly to Pinochet, therefore they were shielded from any group,
business or otherwise, which would want input into the process. However,
pre-existing ties between the Chicago Boys and some of the larger
conglomerates provided high-level informal access to a select, and elite,
group of businessmen. So instead of the ideal "embedded autonomy" in
which an insulated professional bureacracy is able to negotiate policy
reforms with peak business associations, there was an isolated system in
which the key government actors had close ties with a select group of large
businesses. In short, it was a recipe for disaster.
The conglomerates which remained organized around key financial
institutions relied on leverage to finance their activities which were more
speculative than productive in nature. This method proved highly
profitable while petrodollars provided a reliable source of liqudity in the
banking system, and interest remained at a reasonable level. However, when
rates shot up and the the country became illiquid in 1982, many of the
companies were for all intents and purposes bankrupt. Further, other
companies which did not have privileged access to the policy makers
hesitated to invest in a climate of such uncertainty. In 1982, the
Government of Chile (GOC) had little choice but to devalue the peso.
Banks, which were already suffering from what were now bad loans, were also
hard hit by the devaluation's impact on their dollar exposure. The
cumulative effect was a banking crisis which would cost more than 40% of
GDP to clean up. Of developing countries only Argentina's cost more as
percentage of GDP.
The dramatic halt in economic activity once the crisis began caused GDP to
contract by 14 percent in 1982, which in turn pushed the unemployment rate
to 30%. Unlike most Latin American countries, Chile was unique in that
most of its external debt was held not by the government, but by private
companies. It does not appear that there was any real policy battle over
how to handle this dilemma. In 1983, the GOC acted to bail out the
companies by taking on their debt and placing the firms into receivership.
Some statistics are perhaps useful to illustrate this change in debt
structure. In 1981, the GOC's external debt was $4.5 billion, while
private (non guaranteed) external debt totaled $8.1 billion. In 1984, the
year after the bail out, the GOC's external debt increased to $10.6
billion, while the private sector's fell to $6.4 billion. While perhaps
there was no real alternative to this course of action, it seems the
age-old adage of too big (or too influential) to fail applies. Regardless,
it certainly did not hurt that the finance minister who signed off on the
bail out had only a few months earlier been an executive at one of the
country's most indebted conglomerates.
The crisis of the early 1980s put Chile in a difficult position. Twice in
less than ten years GDP had fallen by 12 percent or more, while
unemployment has pushed 30 percent. Clearly, the radical neoliberal
policies of the Chicago Boys, whether from failures in design,
implementation or both, had been a disaster. The political effects of the
crisis have been mentioned above, but the crucial issue became what to do
next. The answer, it seems, came to be known as "pragmatic neoliberalism."
The Chicago Boys had lost credibility, and Pinochet had little choice but
to dismiss the team. The government increased the state's role in the
economy. Import tariffs were raised, price floors were installed to
further protect certain industries, and employment programs were created.
However, these "interventionist" policies went only so far, the neoliberal
model was not tossed aside by any means. In fact by 1985, a new team of
Chicago Boys was brought in to continue the "pragmatic neoliberal"
policies. During this time, the Government also developed a more formal
and regular dialogue with business peak associations. The most important
of which was the Confederation for Production and Commerce (CPC). Further,
the policy makers were no longer so closely linked to a handful of firms.
The new arrangement thus provided for broad private interests to negotiate
with the government on policies to stimulate economic recovery. In other
words the effort was made to make the private sector in general a "winner"
as opposed to a narrow few. As the president of the CPC described;
"Hammering out a consensus within the CPC was a difficult process. But
once completed, we knew that these policies would stimulate production, not
the financial speculation of the past. Once the authorities began to listen
to us, our hope in the future rekindled. Although we don't get everything
we want, we can trust the rules of the game that emerge. As long as they
remain stable, they encourage us to invest."
As the economy began to grown again, the government began to rollback its
interventionist policies. Import tariffs were lowered, utilities and
telecommunications were privatized, as well as those companies in which the
state had intervened. Between 1985 and 1990 average GDP growth was more
than 6%. So, by the time of the transition in 1990, Chile was the best
performing economy in Latin America.
Chile Since 1990
To a large degree the basic economic philosophy seems to have remained
intact, and one can reasonably argue that the transition to a democracy has
been a big help to the country in furthering economic growth. For example
from 1989 to 1990 (the first year under Alywin), net foreign direct
investment inflows jumped from $129 million to $590 million. Further, it
is highly unlikely that Chile would have been the first developing country
to sign a comprehensive bilateral trade agreement with an industrialized
nation (Canada) had Pinochet remained in power.
However, it is important to note that in some ways the center-left
Concertación which won the elections in 1989 did not have complete freedom
in choosing its economic policies. Before handing over the reigns, Pinochet
finally institutionalized the 1980 constitution's language on the role of
the central bank. Namely, that it would be autonomous and in sole control
of monetary policy with its principal aim to defend the value of the peso
by avoiding inflation, and thereby maintaining price stability. The
military regime never seemed to be too concerned over subjecting itself to
these constraints, however. In fact, in the run up to the 1988 plebiscite,
Pinochet relaxed monetary policy to promote consumption. As Delia Boylan
points out, it was only when there was a fear that the new democratic
government might take steps incongruent with the economic policies of the
previous several years that the regime insulated the central bank. The
change was passed by the legislature at the eleventh hour only days before
the December elections, prompting one opposition official to lament, "we
felt we had received something very unfair, very unequal."
Further, even though the Concertación pledged to uphold the "pragmatic
neo-liberal" model, its opposition status required it to reassure domestic
businessmen and foreign investors that the government would "stay on the
path." The method used was similar to that employed by Pinochet's economic
team after 1985. Namely, that the private sector broadly, often
represented by the CPC, would be consulted on economic policy issues from
an early stage. Given the Concertación's interest in achieving growth with
more social equity, the big issues were taxes and labor. While the GOC was
able to obtain private sector agreement to extract more taxes, business
mistrust of how the revenues would be used resulted in sunset clauses being
built into the legislation and that the monies were targeted to specific
programs. The labor issue was more difficult. Given the extremely weak
state of labor due to Pinochet's 1979 law, the negotiations started from a
low base. The 60-day cap on strikes was lifted, and unions were allowed to
join confederations. Additionally, progress was made on issues regarding
job security. However, labor's principal demand, which was obligatory
collective bargaining at the industry (as opposed to the firm) level was
not instituted. Jose Pinera, author of the 1979 Labor Plan, described the
Plan as a building that could not be burned down. Surprisingly enough,
there presently does not seem to be a high level of tension over labor. A
joint end of year survey (1997) by the GOC and University of Chile found
that among the 300 Santiago-based firms, 83.7% believe that labor unions
help labor relations and only 6% believe that they make things more
difficult. Of course, part of the favorable response may be due to the
fact that union affiliation has been falling in Chile since 1991. Further,
labor angst may be tempered by seemingly regular increases in the minimum
wage.
The importance of the Concertación's ability to successfully negotiate
changes, however minor, in the economic program should not be
de-emphasized. During this period, Pinochet still cast a large shadow over
the country. Had the GOC and the business peak associations been unable to
achieve a compromise, it could very well have caused significant political
and economic setbacks.
As mentioned, Chile's economy clearly has its roots in the neo liberal and
"pragmatic" neo-liberal policies under Pinochet. The decision to abandon
ISI strategy in the 1970s, forced those sectors in which Chile had a
comparative advantage to improve their productivity. These sectors,
mining, fishing, and agriculture have led the way. Chile's continued
openness to trade has further ensured that domestic resources are used most
efficiently. It has steadily reduced its unified import tariff to 8% as of
1998, and its merchandise trade to GDP ratio has continued to rise from 33%
in 1983 to at 50.6% in 1990. It has since fallen back a bit to 45% in 1997
(see Table 1 for more years). The liberal trade regime has also assisted
in diversifying Chile's export base. Copper, which used to account for 80%
percent of Chile's foreign exchange now accounts for about half of that.
Other goods that have seen significant exports increases are salmon and
paper products. The services sector has also boomed with 73% rise exports
from $2.13 billion in 1991 to $3.68 billion in 1997 (figures include
tourism). In an October 1998 speech, Carlos Massad, President of Chile's
Central Bank, stated that the number of export companies had increased by
some 60% since 1989, the vast majority of which are exporting less than $1
million per year. Further, he notes that the number of products exported
has grown from 1,490 to 3,771 over the same time period.
Foreign direct investment has been another factor in Chile's economic
growth. Net FDI inflows generally ranged between $120 million and $250
million for most of the Pinochet era, though there were negative flows in
the early years of the regime as well as two years (1981- 1982) during
which net FDI reached about $400 million. Since the transition, however,
it has really taken off. The remarkable rise from 1989 to 1990 has already
been mentioned, and the trend has continued upwards with net flows reaching
$1.7 billion in 1994 and 1995 (See Table 2 for selected years).
The rising trade and investment numbers are impressive and clearly have
played key roles in Chile's economic development, but there are also
important underlying forces which support this growth. Without a strong
belief by the private sector that Chile is a safe country in which to
invest or trade, that contracts will be enforced, that property rights are
secure, that the government will conduct prudent fiscal and monetary
policy, and that corruption will not make life unbearable for business,
then the picture would be markedly different. In nearly every private
sector survey or risk rating, Chile ranks as the best, or among the best in
Latin America. Chile ranked 20th (out of 85) on Transparency
International's most recent corruption ranking. This was far above the
second highest Latin American country and even topped a few in Western
Europe. In the Economist Intelligence Unit's regular risk assessments for
Latin America which examines several types of risk such as economic,
political, currency, debt, etc..., Chile continues to finish at the top in
each category. Duff and Phelps, a rating agency which is very active in
Latin America has recently issued ratings of A- and AA- on Chile's
long-term foreign currency and long-term local currency, respectively. One
of the key reasons is that it believes the GOC will act prudently in
dealing with the current problems in the global currency markets. Namely,
that monetary policy will be kept tight.
Similar impressive results are seen when the analysis becomes more
"scientific." Contract intensive money (CIM), a ratio which Lewis Snider
has convincingly argued is a good measurement of institutional credibility
(e.g., a high degree of public confidence in the security of property
rights, and contract enforcement) is strong in Chile. In 1967 the ratio
was .72, by 1985 it reached .92, and is presently about .93 (see Table 3
for CIM in selected years). These levels are more impressive when one
considers Snider's analysis found that the CIM mean for Developing
Countries, which group Chile was placed, was .767, and that the Adavanced
Developing Countries group had a mean of 914.
Recent events, however, have put a cloud over what has been a sunny
economic picture. Chile's strong export sector is suffering two major set
backs. First, Asia which has accounted for about one-third of Chile's
exports is in a deep recession. Second, while Chile has been able to
diversify its export base copper still accounts for some 40 percent of
export earnings, a sizeable chunk. Thus, when international copper prices
fall, as they have been this year (from an average of 100.7 U.S. cents/lb.
in 1997 to 78.7 cents in 1998), it is painful. These factors have been
strong contributors to the rapid rise in the current account deficit (which
could reach more than 7 percent of GDP for 1998), helping the peso to slip
about 12 percent in the last year.
Ironically, before 1998, Chile tended to focus its energy on trying to
prevent the peso from appreciating by keeping interest rates relatively
low, and placing controls on capital inflows. Now the concern is the
opposite. Annualized interest rates have been as high as 40 percent in
1998, levels not seen in years. The much ballyhooed encaje, Chile's
requirement that 30% of capital inflows be placed in a non-interest bearing
account within the central bank, has been scrapped in an effort to attract
more foreign currency. In June, the Central Bank spent about $1.5 billion,
or just less than 10 percent of its reserves defending the peso.
The result has been a sharp slowdown in economic activity, though the GOC
is still optimistically calling for 5% growth in GDP. In what is clearly a
show of concern over the economy (especially with an election coming up in
1999), the government has submitted a very lean budget for next year and
pledged to limit fiscal growth to at least half a percent below economic
expansion. It is likely that the robust economic growth of the past dozen
years has spoiled Chileans of all classes, but especially the poor. Buoyed
by a relatively strong peso, the population has been able to reach
increasing levels of material well-being. In fact, the absolute number of
Chilean households which live in poverty fell from 45.1% in 1987 to 23.2%
in 1996. Anything which causes these trends to reverse may very well make
life difficult for the Concertación. Further, the much heralded private
pension funds (AFPs) which have done much to help achieve such a high
savings rate, and have been held up as a model for developing and
industrial countries alike, are also reporting losses as Chile's stock
market continues to decline. A protracted economic slowdown could make
what some have considered an "already decided" presidential race much more
interesting.
Financial Sector
Cental Bank
Chile's autonomous Central Bank has been one of Pinochet's lasting
legacies. The manner in which autonomy was achieved has been briefly
discussed above, but some of its attributes deserve further elaboration.
The Central Bank has strict rules regarding direct or indirect financing to
the GOC, it cannot except in war time. Further it holds important policy
making authority, including the control over exchange rate policy, and is
insulated from any finance ministry veto. The bank is further legally
obligated to maintain price stability, and sets yearly inflation targets
(1998 is 4.5%). It will therefore intervene in the market if the exchange
rate deviates more than an established percentage from a reference rate
that is set daily. Over the last several months, the Central Bank has been
tinkering with the band around the reference rate. The band was sharply
narrowed early in the year in an effort to bolster the peso, but has
recently been widened to 5% above or below the reference rate.
The unwavering commitment to maintain price stability is beginning to
cause some strain in the business community. The tight monetary policy has
drained liquidity from the system, a problem exacerbated by speculators
betting against the peso. The effect has been high borrowing rates for
even the most credit-worthy firms. The president of Sofofa (Chile's
industrialists' association) has described the current interest rates as
"suicidal" (annualized inter-bank rates were near 40% in late September),
and has called for a return to the wider exchange rate band of 12.5% above
and below a reference rate.
Stock Market
As with many Latin American stock markets, the early 1990s through the mid
1990s were years of high growth for Chile's stock market. In 1990, there
were 215 domestic companies listed on the exchange with a market
capitalization of $13.6 billion, or about 45% of GDP. By 1995, the number
of companies listed had increased to 284 and capitalization jumped to
nearly $74 billion, or more than 120% of GDP. One of the principal
catalysts for the development of Chile's domestic capital market has been
the private pension funds which are allowed to invest 38% of their assets
in Chilean equities. There is even an electronic bolsa, created at the
insistence of the commercial bankers who wanted to reduce the trading
monopoly that traditional brokers held, which now accounts for about one
quarter of equity transactions.
Since 1995, however, the stock market has not performed very well. This
is somewhat surprising given that Chile's economy was growing strongly
through early 1998. At the end of 1997, even though the number of
companies listed on the exchange had increased to 312, market
capitalization fell to $62 billion or just 82% of GDP. The precipitous
decline continues in 1998, with the market down almost 38% in dollar terms
as of October 14. The weak market has scared off many Chilean firms from
issuing equities as a source of financing.
Banking Sector
The 1981-1983 banking crisis has generally been attributed to the
combination of weak regulation and the dominance of business conglomerates
in the Chilean economy, and prompted the central bank to intervene in more
than a dozen banks and six financieras during this period. The loan
portfolio of these institutions accounted for 60% of the financial system's
total loans. This meltdown brought significant regulatory changes to the
financial system. Principally, banks are prohibited from being the
"financial heart" of these conglomerates, and rules were established to
curtail the intraconglomerate lending which had been so widespread in the
late 1970s. An empirical analysis by Niels Hermes and Robert Lensink in
1998, using a relatively small data set, finds that these new regulations
have been successful in that the "importance of networks between firms and
banks in determining banks' lending decisions appears to have diminished
after the implementation of reforms." In other words, membership in a
Grupo has less of an impact on a firm's ability to access funds.
As a result of these reforms, Chile's banking sector is generally
described as the best regulated in Latin America. Carlose Massad, in the
same speech mentioned earlier, notes that according to an October IMF
report on International Capital Market Development, "Chile's banking
supervision and regulation are among the best in all emerging countries,
and the Chilean banking sector is the strongest in the region." Even the
U.S. Federal Reserve has approved Chile as "having the consolidated
supervision it requires when reviewing foreign bank applications."
Chile's strong regulatory requirments such as its high loan-loss provisions
helped it survive the Tequila effect in 1995, and while many expect that
banks' asset quality will deteriorate in light of current events, the
overall health of the system will not be severely tested.
Another, non-regulatory, trend in Chile, is the gradually increasing
consolidation in the banking sector. In the past two years, four of
Chile's top banks have merged together in two separate deals (see Table 4
for mergers information), further Banco Bilbao Vizcaya, one of the Spanish
giants, has announced that it will acquire one of Chile's larger banks,
Banco Bhif. This trend is expected to continue, with some predicting the
emergence of roughly six large commercial banks, some niche banks, and
several foreign banks with smaller corporate finance operations. Presently
five banks in Chile hold 60 percent of the system's deposits which is up
from 49 percent in 1995. Similarly, HHI ratios havc been slowly increasing
over the past several years, growing from 8.4 in March 1995 to 9.3 in March
1998 (See Table 5 for more years).
The trend towards consolidation seems to link directly to the
globalization of not just Chile's economy, but but of other countries in
Latin America as well. Foreign banks, of which there are several in Chile,
have been expanding their retail banking efforts as the capital markets (at
least before this year) were being increasingly tapped by companies for
financing. This has had the effect of further driving down spreads. At
the same time, the growth of trade and investment, has prompted traditional
retail banks to look more at corporate finance. While there are some
domestic growth opportunities in Chile, with more banks trying to capture a
market in which there is only modest growth, the result has been to "get
bigger" through mergers which provide economies of scale. Further, pushing
this trend along is the 1997 banking law which allows Chilean banks to
expand their domestic business activities by participating in affiliated
companies that provide services such as insurance and factoring.
Additionally, banks can now serve as stock brokers. The law also provides
for Chilean banks to become more international through "foreign loans and
investments, establishing subsidiaries outside the country, and directly
investing in foreign affiliated companies, be it banking entities or
institutions that function as a bank." Chilean banks have been especially
keen to take advantage of the opportunities provided by these rule changes
and have aggressively expanded their regional operations in Peru, and
Argentina. The greater efficiency, improved regulatory practices, and even
the trend towards consolidation have increased the sophistication of the
financial system. In examining Chile's financial depth as measured by
M2/GDP, there is clear upward trend. In 1971 this ratio was .23, while in
1985 it rose to .40 and in 1997 reached .43 (see Table 6 for more years).
For all of the deserved praise the Chilean banking system has received
over the past several years, there are still some areas which could be
cause for concern. In August 1998, The Banker ranked the Top 100 Latin
Banks by "Strength" (using Tier One Capital as the measured variable).
Chile placed four banks in the top 25, more than any other country save
Brazil and Argentina. However, when ranked by "Soundness," as measured by
their Capital Assets Ratio, only one bank even made the top 60. Another,
perhaps worrying issue is that Chile's financial regulators are not as free
from politics as one might prefer. For example, in the throes of the
banking crisis, the central bank spent about $4.5 billion to bail out
several of Chile's largest banks. In 1996, the Central Bank and the debtor
banks engaged in talks to ease the repayment burden on two of the banks.
Chile's Central Bank President at the time, resigned stating that the board
was granting too many concessions. He may have had a good case. The
agreement reached with Banco de Chile allows it to cancel its $1.7 billion
debt over 40 years, beginning in 1997! More recently, the post of Banking
Supervisor, a political appointee position which reports directly to the
President, just changed hands with the old Supervisor now serving as
Minister of Defense. It would seem that in the present tumultuos financial
picture, it would be important to maintain continiuity in a regulatory
system that has been so lauded.
Finally, although after the 1981-1983 banking crisis, the GOC deliberately
put in place policies that would impede banks from becoming the financial
heart of conglomerates, a cursory review of current bank ownership perhaps
raises some flags. In the absence of a strong empirical study, along the
lines of Zeitlin and Ratcliff's Landlords and Capitalists, it is difficult
to say with a high degree of confidence whether the current state of
business is much "cleaner" and better performing than in the late 1970s and
early 1980s or if the right (or wrong) mix of factors just has not yet
materialized to exploit the system's weakness. Whatever the case, after
reviewing a few of Chile's largest banks, nearly all had highly
concentrated ownership, whether in the hands of a family, or holding
company (see Table 7). Some are discussed below.
Banco Santiago, formed by the 1997 merger of Chile's second (Banco de
Santiago) and third (Banco O'Higgins) largest banks is 43.1% owned by
O'Higgins Central Hispano Americano, a Chilean holding company owned 50% by
Banco Central Hispanamericano, Spain's fourth largest banking group and 50%
by the Luksic group, one of Chile's largest conglomerates. The Luksic Group
is possibly Chile's most profitable conglomerate with business interests
ranging from mining to beer. Perhaps one "policing" factor in the case of
Banco Santiago, is that the Central Bank owns 35.4% of the bank, as a
result of the 1985 bailout, though by law this is a non-voting stake.
Since its inception in 1937, Banco de Credito e Inversiones (BCI) has been
in the hands of the Yarur family, which currently controls 72% of the bank,
Chile's fifth largest. The Yarur family has long owned some of Chile's
leading textiles companies. In 1994 a shareholder agreement was reached in
which the family committed to maintaining control of the majority of
shares, but would support the bank's policies and grant independence to its
management.
Banco Sud Americano, the country's eighth largest commercial bank is
controlled by the Borda and Garcia families (BG Group) which own 30.73% of
the shares. Another major shareholder in Sud Americano is the Bank of Nova
Scotia (one of Canada's largest) with 27.84% of the shares. In fact, it
seems that the only bank with a diluted ownership structure is Banco de
Chile, the country's fourth largest bank. The bank's principal
shareholder, Penta Group, has only 5.7% stake in the bank, while the next
15 largest shareholders own a combined 27.5% of the bank. It should be
pointed out, however, that among its other holdings, the Penta Group has a
47.35% stake in one of Chile's 11 pension fund administrators.
It is hard to know exactly what to make of this ownership snapshot. It
seems that in many of the examples cited there is a "policing factor" (e.g.
Central Bank stake in Banco Santiago, or Scotia Bank's stake in Banco Sud
Americano). Concentrated ownership of financial institutions in the hands
of diversified conglomerates does not in and of itself result in opaqueness
or counter- productive business practices because there can be "fire walls"
built between ownership and management control, apparently as in the case
of Banco Credito e Inversiones. It does, though, create an environment in
which unsound business practices can emerge, or reemerge as the case may
be. As discussed earlier there are two trends which are shaping Chile's
financial sector. The first, toward consolidation will witness an
increasing number of mega-banks, ala Banco Santiago and Banco Santander
Chile. The second, thanks to the new banking law, allows commercial banks
to expand into new lines of business, both at home and abroad. Chile is
following the global trend in which the lines that previously divided
insurance companies, commercial banks, and securities firms are becoming
increasingly blurred. The expansion of banks into other financial services
allows them to expand their revenues, and to exploit gaps in the regulatory
framework which simply cannot keep up with the changes brought about by
deregulation in Chile or anywhere else. For example, insurance services
are generally viewed as providing a ceratin "social good" and usually
receive tax breaks because of this. Therefore, a commercial bank has a
strong motivation to repackage a "bank product" as an "insurance product"
in order to reduce its tax exposure. Since the mid 1980s Chile's financial
regulators have received high marks for their ability to keep the system in
check, these trends will undoubtedly test them.
Conclusions & Comparison with Peru
Chile embraced neo-liberal reforms well before most every Latin American
country. The road, however, has not been an easy one. Twice within ten
years Chile's economy came crashing to a halt. The first, in the
mid-1970s, was primarily the result of the "shock" treatment instituted to
begin the reform, and the second, beginning in 1982, due to a global crisis
which was exacerbated by the business practices of Chile's conglomerates
and banks. Through these economic downturns, Pinochet's vice-like grip
over the country prevented a regime change that most likely would have made
substantial changes the economic model. By holding on to power and leaving
office while the economy was growing, Pinochet was able to ensure that the
"pragmatic" neo-liberal policies in effect since the mid-1980s would
continue.
Chile, now effectively run by a center-left coalition government
(Concertación) has continued with these policies, but has sought to put a
"social face" on them. The results have been impressive indeed. High GDP
growth, booming foreign investment, falling inflation and unemployment, and
improved standards of living. In the middle of this has been a highly
regulated financial sector which is considered to be the strongest in Latin
America. In spite of the progress, however, there are things which might
be cause for concern. The large grupos continue to play an important part
in the Chilean economy. Although financial institutions are not permitted
to be the "heart" of these conglomerates, the fact that several banks
continue to be owned by the conglomerates could be a cause for worry. This
could be especially problematic as the lines between banking, securities,
and insurance become more fuzzy, making it more difficult for regulators to
keep up with the changes.
Presently Chile is in an interesting position both economically and
politically. For the first time in several years the growth boom is
slowing. Its very open economy has made it more susceptible than most
changes in the global market place. First, its exports earnings have been
weaker as the Asian markets have dried up, and commodity prices (especially
copper) are low. Second, it's current account deficit has continued to
grow putting increased pressure on the peso. This has prompted the Central
Bank to take steps to shore up the currency, including eliminating capital
inflow controls and raising interest rates. However, for all its efforts,
and the confidence that investors have in the GOC's ability to work through
the crisis, Chile's biggest concern is probably something about which it
can do nothing, Brazil. For if Brazil falls, Chile will find itself in bind.
Next December, Chile will hold its third Presidential election since
Pinochet stepped down. The Concertación is beginning to show signs of
strain given the desire of other, more leftist, parties to want a turn at
supplying the presidential candidate. Should there be a split in the
Concertación, it could give a better opportunity to more conservative
parties. The economic picture over the next year will play an important
part in determining the outcome of this.
Future Work:
As the next step in this process will be to compare Chile and Peru, it is
useful to briefly examine some of the similarities and differences as well
as outline some of the areas on which I plan to focus. Both countries have
embraced neoliberal economic policies, though starting years apart. For
its part Peru has experienced in 1990, what Chile went through in the
mid-1970s, namely shock therapy for the economy. Both rely heavily on
resource based exports for their foreign exchange, as well as foreign
investment. Though both states are "democratic," Peru is more
authoritarian, and the day to day influence of the army in the political
process seems more pronounced than in Chile. Rather interesting given that
Chile's direct experience with military governance is much more recent than
Peru's.
When giving a cursory look to the financial sector, a few things are
immediately obvious. While both country's are trying to deepen their
capital markets (with Chile far ahead), the banking system is consolidating
and expanding into new areas of business. The countries are almost
straddling the line between the German and Anglo-Saxon models of
capitalism. In Peru, the driving force behind consolidation seems to be
that the best manner in which to fully serve a still growing market is to
merge, while in Chile the market is somewhat saturated, and the only way to
grow one's share is to get bigger. Similarly, the two countries are
praised for their strong supervision over banks, but this will undoubtedly
be tested as the lines among insurance companies, securities firms, and
banks are removed through deregulation.
In addition to fleshing out the above issuess out more in a final paper,
another important piece that will receive attention is the relationship
between business and the government. In the case of Chile, the private
sector has been in more or less direct contact with the government since
the mid-1980s., while in Peru it appears that the while business is
represented through the appointment of businessmen to cabinet posts, there
is not much institutionalized negotiation. BIBLIOGRAPHY
Boylan, Delia M.. "Central Bank Reform in Chile's Transition from
Authoritarian Rule." Comparative Politics Vol. 30 No. 4: July 1998
443-462.
"Against All Odds." Business Latin America. 28 Sept. 1998: 2.
"Cleaning House." Business Latin America. 27 May 1996: 2-3.
"Greasy Palms." Business Latin America. 5 Oct. 1998: 8.
"Things that go bump in the night." Bussiness Latin America. 30 March
1998: 4-5.
Economist Intelligence Unit. Country Profile: Chile 1991-1992. London 1992.
Economist Intelligence Unit. Country Profile: Chile 1997-1998. London 1998.
Florencio, Jose. "Special Report on Chile." LatinFinance. Nov. 1996
Online University of Texas Lib.
Haggard, Stephan and Robert R. Kauffman. The Political Economy of
Democratic Transitions. Princeton: Princeton University Press, 1995.
Hermes, Niels and Robert Lensink. "Banking Reform and the Financing of
Firm Investment: An Empirical Analysis of the Chilean Experience,
1983-1992." Journal of Development Studies v34 n3 Feb. 1998. Retreived
online University of Texas at Austin Lib.
Jones, Andrew. "Re-theorizing the core: a globalised business elite in
Santiago, Chile." Political Geography Vol 17. No. 3 Mar. (1998): 295-318.
"Social Agenda Still Running." Latin American Monitor-Southern Cone. Aug.
1998: 5.
"Lagos launches nomination bid ." Latin American Regional Reports -
Southern Cone 8 Sept.
1998: 2-3.
"Frei Reshuffles the Cabinet." Latin American Monitor-Southern Cone Sept.
1998 4-5.
Luft, Kerry. "Chile Embraces Chicago Boys; Once Reviled Now Hailed, Team
Helped Reshape a Battered Economy." Chicago Tribune 12 Nov. 1995
(Chicagoland Final Edition) Sec. Business: 2.
Massad, Carlos. Speech: "The Chilean Economy: Strengths and
Perspectives." Oct. 1998. Retreived from Chilean Central Bank homepage.
Maxfield, Sylvia and Ben Ross Schneider ed. Business and the State in
Developing Countries. Ithaca: Cornell University Press, 1997.
Mahon, James. Mobile Capital and Latin American Development.
Pennsylvania: Penn State Press 1996.
"DCR Reaffirms Chile's A- Foreign Currency Rating; Outlook Stable," PR
Newswire Sec. Financial News: 28 Sept. 1998. Online University of Texas
Lib., Internet 12, Oct. 1998.
"Chile Approves Debt Agreement with Private Banks." Reuters Financial
Service Sec. Financial Report: Bonds Capital Markets. 17 Sept. 1996
Online University of Texas Lib.
Rosenfield, Stephanie. "The myth of the Chilean miracle," Multinational
Monitor, July-Aug. 1994 v15 n7. Retreived via UT Library Online.
Silva, Eduardo. The State & Capital in Chile. Colorado: Westview, 1996.
Silva, Eduardo. "From Dictatorship to Democracy: The Business-State Nexus
in Chile's Economic Transformation, 1975-1994." Comparative Politics
Vol. 28 No. 3 April 1996: 299-320.
Snider, Lewis. Growth Debt and Politics. Colorado: Westview Press 1996.
Report on Banco de Chile. Solomon Brothers 1 May 1997. Online University
of Texas Lib. Investext.
Taylor, Robert. "Private Sector Revolution." The Banker. Aug. 1998 54-60.
"Chilean Bank Doubles Presence in U.S." Thomson's International Banking
Regulator. 27 Oct. 1997 Online University of Texas at Austin Lib.
Report on Banco Santiago. Thomson's Bank Watch 13 July 1998. Online
University of Texas Lib. Investext.
Report on Banco Credito E Inversiones. Thomson's Bank Watch 17 July 1998.
Online University of Texas Lib. Investext.
Report on Banco Sud Americano. Thomson's Bank Watch 20 Aug 1997. Online
University of Texas Lib. Investext.
The World Bank. World Development Report 1997: The State in a Changing
World. New York: Oxford 1997.
Zietlin, Maurice and Richard Ratcliff. Landlords and Capitalists.
Princeton: Princeton University Press 1998.
End Notes
CHILEAN INDICATORS FOR SELECTED YEARS
TABLE 1 Merchandise Trade as a Percent of GDP (Selected Years)
1983 1987 1990 1994 1997
33% 34% 50% 42% 45%
TABLE 2 Net Flows of Foreign Direct Investment (U.S. Millions) (Selected
Years)
1970 1974 1980 1985 1989 1994 1995
($79) ($557) $213 $114 $1,289 $1,773 $1,695
TABLE 3 Ratio of Contract Intensive Money (M2-C/M2) (Selected Years)
1967 1971 1975 1980 1985 1990 1995 1997
0.72 0.7 0.73 0.87 0.92 0.92 0.93 0.92
Table 4
Chile's Consolidation Trend
Year Bank Rank Before Merger New Name Rank After Merger
1996 Banco Santander 5 Banco Santander Chile 3
Banco Osorno 7
1997 Banco O'Higgins 4 Banco Santiago 2
Banco de Santiago 6
199X Banco Bilbao Vizcaya 0 ?????? ???????
Banco Bhif 10
Others Reported to be Considering Mergers
Banco de Chile 2
Banco de Edwards 8
TABLE 6 Financial Depth (M2/GDP) (Selected Years)
1967 1971 1975 1980 1985 1990 1995 1997
0.14 0.23 0.14 0.25 0.4 0.38 0.37 0.43
Table 7
Bank Total Assets Ownership Composition
(1Q98 $M)
Banco Santiago $8,357 O'Higgins Central Hispano 47.3%
Americano (50-50 JV btwn
Luksic Group & Banco Cental
Hispano)
Central Bank of Chile 35.4%
Hong Kong Shanghai 7.0%
Banking Corp.
ADR Holders 10.3%
Banco Santander Chile $6,301 Santander Spain 74.65%
Perez Compac Group
(Argentina) 6.0%
ADR Holders 15.0%
Others 4.35%
Banco de Chile $5,897 Penta Group 5.7%
Next 15 largest shareholders 27.5%
Others 66.8%
Banco del Estado $5,844 Chilean Government 100%
Banco de Credito $3,955 Yarur Family 72%
e Inversiones Others 18%
Banco Bhif $2,428 Controlling Group (unamed) 67.72%
Local Investors 15.03%
ADR holders 14.25%
Bank Employees 3.0%
Banco Sud Americano $2,423 BG Group 30.73%
Bank of Nova Scotia 27.84%
Lampebank International 9.95%
(Germany)
Other shareholders 31.48%