Chile and Peru Comparison (Part I)
Bill (portaro@erols.com)
Mon, 14 Dec 1998 11:48:15 -0500
very much in common. After all, Peru is a country of about 24 million,
a large percentage of whom are indian, and for many years was considered
an economic basket case plagued by terrorism. Chile, on the other hand,
boats a remarkably homogenous population (for Latin America) of about 15
million, and has often been touted as the poster boy for economic
liberalism and its benefits. On closer examination, however, one may be
surprised at some of the similar experiences that the two countries have
had, especially with respect to the neoliberal reforms that both have
embraced. This paper will focus on this topic arguing that while there
are of course some important differences in responding to the
globalization phenomena, the similarities are rather impressive. The
paper is organized into five sections. The first will be a brief
overview of the neoliberal reforms and their political implications in
each country. This will be followed by a more detailed look at the role
of the private sector, and especially the conglomerates (grupos) in this
process. The third section will examine the implications of the reforms
on the financial sector, and specifically the banking system. The
fourth part will be a short assessment of what the future might hold.
Finally, the paper will offer some conclusions and possible theoretical
implications. Attached is a statistical appendix to provide the reader
with a more quantitative comparison between the two countries.
Reference will be made to these tables throughout the text.
Political Economy of Neoliberal Reforms
The years 1973 and 1990 were watershed ones for Chile and Peru,
respectively. 1973 witnessed a military coup which brought General
Augosto Pinochet to power for some sixteen years, while 1990 brought the
surprise victory of a political unknown, Alberto Fujimori, in Peru's
presidential election. Both came to power during a period of profound
economic and political crises, and the two moved quickly to attack both
sets of problems. Before discussing some of the specific reforms,
however, it is perhaps useful to briefly revisit the circumstances that
brought about such sharp transformations.
In 1970, the world's first democratically elected Marxist President,
Salvador Allende took office in Chile. Elected with less than 40
percent of the vote, he sought to implement a "radical nationalist and
socialist" economic platform . Allende nationalized companies,
instituted price controls, and raised wages. Despite support by some
sectors of the working class, these policies sparked an economic and
political crisis. Inflation became rampant, the country suffered from
severe balance of payment problems, and a failed attempt by Allende to
secure a legislative majority left the government paralyzed. The
result, increased calls for military intervention from opposition
groups, and an ambivalence by others because of the rapidly
deteriorating economic situation.
In Peru, the dam took a little longer to break. From 1968 to 1980, the
country was under military rule. The first period (1968-1975),
witnessed massive state intervention in the economy, pushing state-owned
enterprise contribution to GDP from 1 percent in 1968 to 20 percent in
1975. These policies, which alienated the business sector, were
somewhat reversed when a more conservative regime took over from
1975-1980. The late 1970s, however, were characterized by labor unrest,
military infighting, unimpressive economic growth, and repression, all
of which forced a discredited armed forces to negotiate a return to
civilian rule. The return to democracy gave Peruvians high hopes for
both the moderate Belaunde (1980-1985) and the more populist Garcia
(1985-1990). However, global recession, the debt crisis, and periods of
severe weather made economic growth quite difficult. Garcia had limited
short-term success early in his term, but his recalcitrance in dealing
with the IMF, and other creditors (e.g., limiting debt payments to a
fixed percentage of exports) had a high price. The "last straw" was
his failed attempt to nationalize the banking system. The country
became more fractured, with a business sector that was estranged from
the government, and an increase in urban and rural violence from the
Shining Path. By 1990, Peru had reached its nadir. The country was in
shambles: GDP had contracted by 20 percent over the previous two years;
annual inflation was more than 2,700 percent; its international reserves
were depleted; it was in arrears on two-thirds of its foreign debt and
thus ostracized as a pariah state by the international financial
community. Further, it was in the midst of a bloody war with a
home-grown terrorist organization bent on overthrowing the state.
In both countries, the new leaders acted rather quickly to consolidate
their rule and eradicate domestic political threats as well push for
radical neoliberal reform. It is somewhat ironic that in Chile many
centrist political groups supported the coup under the impression that
it would be a temporary measure, while Fujimori had campaigned on a
platform critical of neoliberal reform. Nevertheless, both men were
able to exploit a political system that had become fractionalized and
polarized to implement their policies with minimal resistance. As part
of Pinochet's tactics to crush subversion he banned all political
activities. For his part, Fujimori carried out his famous autogolpe
(dissolving the legislative and judicial branches) early in his
administration, arguing that Peru's problems could only be addressed
through quick and decisive actions.
Both Presidents wasted little time in implementing neoliberal reforms,
with reigning in inflation as the number one priority. Pinochet's
"Chicago Boys," who held a virtual monopoly on all key economic posts,
including the ministries of finance, planning and the treasury, as well
as the budget office and the central bank, removed most price controls
and subsidies, slashed state employment roles, and lowered tariffs.
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. In Peru, many similar steps were taken.
Tariffs were slashed from rates as high as 100 percent to an average of
15 percent. Capital controls were eliminated, and a massive
privatization program lured foreign investment. These reforms were
further supported with other "structural adjustments" under the close
supervision of the IMF and the World Bank. Subsidies and price controls
were eliminated, a new tax system was developed, and laws were passed
making it easier to hire and fire workers. The "Fujishock" policies
also initially made things much worse as inflation approached 8,000
percent in 1990, before coming back down in 1991.
Before continuing with the changes that these reforms brought, it is
important to remember that given Chile's experience with reforms it is
natural that one would expect to see more adjustments. For example,
during Pinochet's term, there were a few periods in which the economy
sharply contracted prompting modifications in the country's liberal
economic policies. In contrast, Peru has not yet experienced a
prolonged period of negative growth or rapidly rising inflation since
the reforms began. Before returning to Peru then, it is helpful to see
the transitions and experience that Chile has gone through since the
1970s.
By 1976, Chile was again growing (average GDP growth was 7 percent
through 1981), inflation was falling and, a middle class emerging,
bolstered by an overvalued peso. Pinochet quickly capitalized on these
"good times" by pushing through reforms which further emasculated labor
and ushering in a new Constitution that secured his power for another
decade. Unfortunately, the "miracle," as some came to call Chile's
growth could not be sustained as it was based more on speculative
activities such as financial intermediation and real estate rather than
productive investment . The overvalued peso further fostered a
consumption boom with the current account deficit rising from $1.8
billion in 1980 to $4.8 billion in 1981.
The onset of the debt crisis put Chile in a difficult position. Twice
in less than ten years GDP had fallen by 12 percent or more, while
unemployment had pushed 30 percent. Clearly, the radical neoliberal
policies of the Chicago Boys, whether from failures in design,
implementation or both, had been a disaster. Pinochet had little choice
but to dismiss his discredited economic team, and increase the state's
role in the economy. 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 implement
policy under the new banner of "pragmatic neoliberalism." As the
economy began to grow again, the government rolled back its
interventionist policies. Between 1985 and 1990 average GDP growth was
more than 6 percent. So by the time of the transition in 1990, Chile
was the best performing economy in Latin America.
The post-Pinochet economic philosophy has remained largely 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. This
upward trend has continued with net flows reaching $1.7 billion in 1994
and 1995 (See Table 2 for selected years). However, it is important to
note that in some ways the center-left Concertación, which won the
elections in 1989, was conducting policy with an economic straight
jacket. Before handing over the reigns, Pinochet finally
institutionalized the autonomous role of the central bank as set out in
the 1980 Constitution, a constraint to which the military never bother
subjecting itself. 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."
Chile's decision to continue with liberal economic policies has forced
those sectors (mining, fishing, agriculture) in which the country had a
comparative advantage to improve their productivity, though other
sectors such as services exports, including tourism, have also posted
strong gains. Chile's continued openness to trade has further ensured
that domestic resources are used most efficiently. Its unified import
tariff now stands at 8 percent, and its merchandise trade to GDP ratio
has continued to rise from 33% in 1983 to at 50.6% in 1990, though it
has since fallen back a bit to 45% in 1997. The liberal trade regime
has also assisted in diversifying Chile's export base. Copper, which
had brought in 80% percent of Chile's foreign exchange now accounts for
about half of that. 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.
While Peru has not had as much experience under neoliberal reform, the
policy shifts of Fujimori have transformed the country. GDP growth has
been more than 7 percent from 1993-1997 (with the exception of 1996). A
massive privatization program, as well as more stable business climate
has helped bring billions of dollars of foreign investment into the
country (see Table 2 for selected years). Furthermore, by once again
servicing its external obligations, Peru has regained respectability in
the eyes of the international financial community, something very
important given the country's high level of indebtedness.
Fujimori and Pinochet share another important trait that has allowed
them to carry out liberal economic policies, the ability to keep
political opponents of reform largely at bay. At first, both benefitted
from the failures of their predecessors, and thus were able to use the
"honeymoon period" to implement radical reform. However, in times of
opposition the two presidents were not above resorting to drastic
measures. In the early 1980s when protests against Pinochet's economic
policies threatened to bring down the regime, the dictator resorted to
repression of the kind not seen since the time of the coup. For his
part, Fujimori has taken pains to maintain the support of the military.
Without their backing, the autogolpe would certainly have not taken
place. A new Constitution in 1993 significantly strengthened an already
powerful executive, and the pro-Fujimori legislative branch is a virtual
rubber stamp. Any unfavorable ruling from the judiciary is often met
with the dismissal of the guilty judge.
This type of environment makes the Chilean transition back to
democracy all the more interesting. First, there was no economic
crisis. This is very much unlike Peru, and 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 in a more or less cohesive fashion under a
centrist banner, pledging to continue the economic policies of the
Pinochet regime. The timing is important because by Pinochet going out
on a high note, so to speak, not only guaranteed continuation of liberal
economic policies, but also allowed him to exercise a high degree of
control over the transition process.
In Peru, a "redomcraticzation" of the political system is difficult to
see during a Fujimori administration. A divided opposition, and an
electoral law which denies party status to a political group that did
not obtain at least five percent of the vote in the 1995 legislative
elections make a "congressional veto" unlikely. Instead, Peru may
experience more anti-government rallies like that of September 30, 1998
during which 5,000 protestors broke through a barricade surrounding the
Presidential Palace, and a smaller number caused damage inside the
residence. The main participants were union workers complaining about
high levels of unemployment and calling for an end to privatization, and
students who were protesting for democracy. There were similar
demonstrations in other Peruvian cities. The size and violence of the
march were surprising given the drastically weakened power of unions
since the 1980s when mass protests were a regular occurrence. Should
such protests continue, Fujimori could face an interesting situation.
By refusing to listen to cries for improved democratic institutions, or
worse, taking a harder line against them, he risks scaring off the
foreign investors on whom Peru heavily depends. On the other hand, by
taking a more populist position and significantly slowing privatizations
(something that appears to be happening already) or other reforms, he
may also spook investors.
BUSINESS STATE RELATIONS (THE ROLE OF GRUPOS)
The late 1960s and early 1970s brought the rapid fall of the
landed-elite in Peru, Chile. The Allende and, to a lesser extent, Frei
regimes in Chile as well as the Velasco government in Peru deliberately
neutralized the power of this historically powerful class. Stepping
into its place was a new group consisting of industrialists and bankers
based in the capitals of Lima and Santiago. As is the case in most
present day Latin American countries, it is now the urban elite led by
conglomerates, or grupos, that dominate the economic picture. Peru, and
Chile are no exception to this, and in fact the grupos have played
important roles in the political economy of both countries.
In general grupos in Chile have had a longer history as economic actors
than those in Peru. As early as 1959, just 4% of the stock companies
controlled about 60 percent of the circulating capital. These
industrial grupos 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, the firms 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.
Pinochet's reforms did nothing to change the concentration of economic
power in the hands of these large firms. 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. This perhaps would not
have been so dangerous had Pinochet's economic team, which had
preexisting ties to many of these firms, not granted privileged access
to these businessmen. So instead of the ideal "embedded autonomy" in
which an insulated professional bureaucracy 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 liquidity in
the banking system, and interest remained at a reasonable level.
However, when rates shot up and 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 had a crippling
effect on the private sector. 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 help illustrate this
point. 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 little 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.
Under Pinochet's "pragmatic" neoliberalism, the Government 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.
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. While the 60-day cap on strikes was lifted, and unions were
allowed to join confederations, labor's principal demand, 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. 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.
Like Chilean grupos, Peru's conglomerates were tied together through
interlocking directorates and had significant holdings in commercial
banks. Similarly, they preferred to maintain relationship with the
state that was based more on informal access rather than under a
structured system which would provide access to the private sector
broadly. As Thorp and Dutrand discuss, the lack of formal communication
between these two organizations (and within the business community
itself) resulted in a situation where individual companies would seek to
protect their own interests without consideration to policies that could
help the business sector as a whole. This philosophy, on the one hand
allowed each grupo to work with the different regimes in Peru, but
generally prevented a united front from being formed on policy issues.
Perhaps this discreet relationship is best exemplified by President
Garcia's relationship with the "12 Apostles," the nickname for the
heads of the 12 grupos, with whom Garcia tried to coordinate a national
investment program, without consulting the business sector at large.
Somewhat ironically, these grupo heads were among the first to attack
Garcia over the bank nationalization issue. It was only in 1984 that
the private sector formed a business peak association (CONFIEP), and
even then it was not until 1987 with the attempted bank nationalization
by Garcia, that business community broadly mobilized behind a common
goal. The success of the victory in the "battle of the banks" seems to
have marked a turning point for the Peruvian private sector, and
especially the grupos which appear to better appreciate the benefits
that can be derived from a message that is delivered with "one voice."
According to Durand, CONFIEP "also played a leading role in terms of
establishing a new and broader consensus over trade liberalization
policies adopted by Fujimori's government in 1990." The organization
also backed the 1992 autogolpe. In spite of a better organized and
supportive business community, one gets the impression that the highly
centralized, Fujimori decision making structure does not leave much room
for consultation with outside organizations, business or otherwise.
Even without structured access, however, private sector interests seem
to be represented at high levels in the Fujimori government by the
seemingly constant placement of "businessmen" in important posts.
Probably the best example is the tenure of Jorge Camet Dickman, who
served in the key position of Economy Minister from 1993-1998. Prior to
his appointment into the Fujimori administration, Mr. Camet had served
as head of CONFIEP.
THE FINANCIAL SYSTEM
While neoliberal reforms have drastically transformed the Chilean and
Peruvian economies, the policies have had an especially significant
effect on the banking systems in each country. In Peru, the 1970s and
1980s witnessed an increase in the level of state intervention in Peru's
banking system, which at its peak saw the government control nearly 75
percent of the country's financial resources. Over time, the
distortions in resource allocation and interest rates that these
policies caused served to undermine public confidence in the banking
system. In 1987, President Garcia, no longer able to manage this
situation, attempted to nationalize the domestic commercial banking
system. Garcia badly miscalculated his support for the initiative, and
there was an immediate outcry from businesses and opposition
politicians, ultimately forcing Garcia to back down. The end result of
these interventionist policies (including pre-Garcia) was a disaster.
Foreign banks withdrew from Peru due to a discriminatory legal
structure; capital flight, and hyperinflation caused volumes
intermediated by the commercial banks to plunge to one-third of the
levels reached in the mid-1980s; and non-performing loans had increased
to about 25 percent of total loan portfolios. By, 1988, nearly all
state-owned banks were bankrupt.
In Chile, the spark that drove reform was somewhat different. After
Allende's overthrow, nearly all of the nationalized banks were
reprivatized rather quickly. The fact that the banking system was in
private hands, however, did not prevent a major crisis in the sector
from 1981-1983. The cause of the crisis has generally been attributed
to weak regulation allowing dangerous intra-conglomerate lending to
flourish. The central bank was prompted to intervene in more than a
dozen banks and six financieras during the crisis period. The loan
portfolio of these "intervened" institutions accounted for 60% of the
financial system's total loans.
The meltdown of the banking system in Chile and the Fujimori election
brought significant regulatory changes to the countries, both of which
are now considered among the region's best supervised. In March 1998,
Duff and Phelps Credit Rating Co. assigned a BB long-term foreign
currency rating to Peru, citing among other factors, "A highly
capitalized, very liquid and well provisioned banking system. A solid
regulatory system and a capable and appropriately staffed supervisory
agency reinforce the banking system's relative strength." Chile has
received even more widespread acclaim. Carlos Massad, in the same
speech mentioned earlier, notes that according to an October 1998 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."
Both countries survived the 1995 "Tequila Effect" virtually unscathed
owed in large part due to stringent oversight. While the present
difficulties in Asia and with El Niño will certainly put pressure on the
banking systems in both countries (e.g., past due loans in Peru shot up
29 percent in the first quarter of 1998, largely due to El Niño ), the
general belief is that the systems' overall health will not be severely
tested. Each country has also adopted tougher standards than those
found in the Basle Accord. In Chile, banks are now prohibited from
being the "financial heart" of conglomerates, a problem that had been
widespread in the late 1970s, a similar law in Peru limits loans from
banks to companies with direct links to those same banks. An empirical
analysis by Niels Hermes and Robert Lensink in 1998, using a relatively
small data set, finds that Chile's 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.
One of the trends taking shape in Chile and Peru, is the increasing
consolidation within the banking sector. The past several years have
witnessed several of the larger banks either merging or being acquired
by other, especially foreign, banks. In Peru the role of foreign banks
has been especially pronounced with 13 of the 24 existing banks
controlled by foreign capital, and 57 percent ($578 million) of the
banking system's equity in foreign hands. Spanish giants Banco Bilbao
Vizcaya, and Banco Santander have been extremely active in the two
countries. This trend is expected to continue, with some predicting in
the Chilean system to be comprised of roughly six large commercial
banks, some niche