The Long FAQ on Liberalism

A Critique of the Chicago School of Economics:



CHILE: THE LABORATORY TEST

Changes in U.S. Gross National Product, by President Year % Change in GNP President 1930 -9.4% Hoover 1931 - 8.5 Hoover 1932 -13.4 Hoover 1933 - 2.1 Hoover/Roosevelt 1934 + 7.7 Roosevelt 1935 + 8.1 Roosevelt 1936 +14.1 Roosevelt 1937 + 5.0 Roosevelt 1938 - 4.5 Roosevelt 1939 + 7.9 Roosevelt

The economy grew an astonishing 14 percent in 1936  the strongest peacetime year in U.S. history. But does that mean that people were enjoying champagne and caviar during the Great Depression? Of course not. The economy was simply making up lost ground. Likewise, the U.S. recessions of 1980-82 were the worst since the Great Depression, and these were followed by an unusually strong seven-year boom: the so-called "Reagan years."



What's going on here? Two economic concepts are useful to understand this phenomenon. The first is that the economy grows in the long run, as both the population expands and each worker produces more per hour, thanks to improving technology and efficiency. This long-term growth experiences mild swings in the form of recessions and recoveries, of course. But if the economy grows in the long run, then deep recessions are going to be followed by even steeper recoveries.



The second concept is the distinction between actual productivity and potential productivity. "Potential" is a somewhat misleading term, since it implies something imaginary, but this productivity does indeed exist. Potential productivity reflects our nation's productive capacity (in the form of our workers, factories, etc.). Actual productivity reflects how much of that capacity is actually being used. For example, a factory may have the potential to turn out 3,000 cars a month. During a recession, however, its actual productivity may fall to only 1,500 cars a month. Actual growth would occur if the factory returned to a full capacity of 3,000 cars. Potential growth would occur only if a second factory were built.



During a recession, actual productivity drops as millions of workers are laid off and factories sit idle. But all the potential productivity is still there. During a recovery, actual productivity climbs closer to its potential, as millions of laid-off workers return to empty factories. This gives the appearance of growth  and we should note that this type of growth is relatively quick and easy to achieve. But what happens when all the workers have returned? Then any further growth will have to involve potential growth  that is, the construction of factories and the birth of new workers. As you might imagine, this type of growth is considerably more difficult to achieve.



So this is all that happened that during Chile's "Economic Miracle"  laid-off workers returned to their old jobs. When you take both the recession and recovery into account, Chile actually had the second worst rate of growth in Latin America between 1975 and 1980. Only Argentina did worse. (6)



And even then, much of Chile's growth was artificial or fictitious. Between 1977 and 1981, 80 percent of Chile's growth was in the unproductive sectors of the economy, like marketing and financial services. Much of this was speculation attracted to Chile's phenomenally high interest rates, which, at 51 percent in 1977, were the highest in the world. (7)



Chile's integration into the world market would leave it vulnerable to world market forces. The international recession that struck in 1982 hit Chile especially hard, harder than any other Latin American country. Not only did foreign capital and markets dry up, but Chile had to pay out stratospheric interest rates on its orgy of loans. Most analysts attribute the disaster both to external shocks and Chile's own deeply flawed economic policies. By 1983, Chile's economy was devastated, with unemployment soaring at one point to 34.6 percent  far worse than the U.S. Great Depression. Manufacturing production plunged 28 percent. (8) The country's biggest financial groups were in free fall, and would have collapsed completely without a massive bail-out by the state. (9) The Chicago boys resisted this measure until the situation became so critical they could not possibly avoid it.



The IMF offered loans to help Chile out of its desperate situation, but on strict conditions. Chile had to guarantee her entire foreign debt  an astounding sum of US$7.7 billion. The total bailout would cost 3 percent of Chile's GNP for each of three years. These costs were passed on to the taxpayers. It is interesting to note that when the economy was booming, profitable firms were privatized; when those firms failed, the costs of bailing them were socialized. In both cases, the rich were served. (10)



After the IMF loans came through, the Chilean economy began recovering in 1984. Again, it saw exceptionally high growth, averaging about 7.7 percent a year between 1986 and 1989. (11) But like the previous cycle, this was mostly due to actual growth, not potential growth. By 1989, the GDP per capita was still 6.1 percent below its 1981 level. (12)



So what was the record for the entire Pinochet regime? Between 1972 and 1987, the GNP per capita fell 6.4 percent. (13) In constant 1993 dollars, Chile's per capita GDP was over $3,600 in 1973. Even as late as 1993, however, this had recovered to only $3,170. (14) Only five Latin American countries did worse in per capita GDP during the Pinochet era (1974-1989). (15) And defenders of the Chicago plan call this an "economic miracle!"



Aggregate statistics are somewhat better. Between 1970 and 1989, Chile's total GDP grew a lackluster 1.8 to 2.0 percent a year. That was slower than most other Latin American countries, and slower than its own record in the 60s. (16)



With the economy booming in 1988, however, the government felt it safe to honor a requirement of its new constitution: a yes-no vote confirming the presidency of General Pinochet for another eight years. But the government's confidence turned out to be self-deluded, and Pinochet lost the vote. This called for another set of more open elections in 1989. The fragmented opposition united to defeat Pinochet, who was replaced by Patricio Aylwin, a moderate candidate from the Christian Democratic party. However, Pinochet remains as head of the military. Today democracy is restored in Chile, but a laissez-faire culture persists, and many social programs (like social security) remain privatized. Chile's economic course seems to have been permanently altered.



The deterioration of labor



Chile's erratic economy and ultimately slow growth are not the worst legacy of the Chicago boys. The standard of living for workers crumbled under the Pinochet regime. In fact, this is a truly horrific part of the story.



By all measures, the average worker was worse off in 1989 than in 1970. During this period, labor's share of the national income fell from 52.3 to 30.7 percent. (17) Even during the second boom (1984-89), wages continued to fall. The following index shows the decline in both average and minimum wages:

Evolution of real wages, revised index, 1980-87 (in percent) (18) Year Average Wage Minimum Wage 1980 95.0% 97.7 1981 105.0 102.3 1982 110.3 101.2 1983 91.1 79.3 1984 86.5 69.5 1985 80.0 64.7 1986 81.5 60.3 1987 81.2 55.5

By 1989, Chile's poverty rate was 41.2 percent, one-third of them indigent or desperately poor. (19) Shanty towns known as poblaciones grew around Santiago and other major cities, kept alive by las comunes, or soup kitchens. In 1970, the daily diet of the poorest 40 percent of the population contained 2,019 calories. By 1980 this had fallen to 1,751, and by 1990 it was down to 1,629. (20) Furthermore, the percentage of Chileans without adequate housing increased from 27 to 40 percent between 1972 and 1988, despite the government's boast that the new economy would solve homelessness. (21)



Meanwhile, the wealthy were raking it in. The following chart shows how the richest 20 percent of society enlarged their share of the pie at the everyone else's expense. (Note: the "first quintile" represents the poorest 20 percent of society, the "fifth quintile" the richest 20 percent. The percentage numbers here represent the share of national goods consumed by that quintile.)

Consumption by Household Quintiles (percent distribution) (22) Quintile 1970 1980 1989 First (poorest) 7.6% 5.2 4.4 Second 11.8 9.3 8.2 Third 15.6 13.6 12.7 Fourth 20.5 20.9 20.1 Fifth (richest) 44.5 51.0 54.6

Chile's income inequality also became the worst on the continent. In 1980, the richest 10 percent took in 36.5 percent of the national income. By 1989, this had risen to 46.8 percent. By contrast, the bottom 50 percent of income earners saw their share fall from 20.4 to 16.8 percent over the same period. (23)



Income was not the only thing that concentrated in the hands of the few; so did production. Once the Chicago boys deregulated the market, oligopolies rapidly formed in virtually every sector. The chart below shows how many large export firms controlled what percentage of their industry:

Concentration in the Export Sector by Main Industry, 1988 (24) Industry # of firms Industry share Paper, cellulose 2 90.0% Chemicals 2 71.4 Wine and Beverage 2 70.2 Forest products 5 78.4 Food 6 67.3 Fish products 6 51.1 Mining 7 97.1 Wood 7 78.6 Agriculture 8 80.6

How did such extreme inequality come about? It was part of an intentional policy to keep unemployment as high as possible. (25) Widespread unemployment has the effect of driving down wages, as unemployed workers compete for a limited number of jobs, accepting even sub-poverty wages to get them. Many promoters of the "free market" forget  or probably exploit  the fact that the labor market is like any other market: dictated by the laws of supply and demand. To see how this works, imagine a land where the supply of workers perfectly matches the employers' demand for them, and everyone gets paid $10 an hour. What happens if we add a few more workers to this economy? Economist Paul Krugman explains:

"The way that a freely functioning labor market ensures that almost everyone who wants a job gets one is by allowing wages rates to fall, if necessary, to match supply to demand " (26)

"I have nothing good to say about the political regime that Pinochet imposed. It was a terrible political regime. The real miracle of Chile is not how well it has done economically; the real miracle of Chile is that a military junta was willing to go against its principles and support a free-market regime designed by principled believers in a free market. The results were spectacular. Inflation came down sharply. After a transitory period of recession and low output that is unavoidable in the course of reversing a strong inflation, output started to expand, and ever since, the Chilean economy has performed better than any other South American economy.



"In Chile, the drive for political freedom, that was generated by economic freedom and the resulting economic success, ultimately resulted in a referendum that introduced political democracy. Now, at long last, Chile has all three things: political freedom, human freedom and economic freedom. Chile will continue to be an interesting experiment to watch to see whether it can keep all three or whether, now that it has political freedom, that political freedom will tend to be used to destroy or reduce economic freedom." (31)

"The liquid that emerges from the millions of faucets in the homes and alleys of Santiago have levels of copper, iron, magnesium and lead which exceed by many times the maximum tolerable norms. [The lands that] supply the fruits and vegetables of the Metropolitan Region are irrigated with waters that exceed by 1000 times the maximum quantity of coliforms acceptable. [This is why Santiago] has levels of hepatitis, typhoid, and parasites which are not seen in any other part of the continent." (35)

"In his speeches and articles, Piñera credits the Chilean pension model with producing just about everything short of the second coming of Christ: pensions that are 40-50 percent higher than under Social Security; security for the old; lower costs due to the 'fact' that the private sector is much more efficient than the public; a rate of savings rivaling that in an Asian 'tiger' economy; and even the end of class conflict in Chile." (38)