CHILE: CHALLENGES TO THE FREE-MARKET MODEL

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83S00855R000100090001-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 17
• Document Creation Date: December 21, 2016
• Document Release Date: August 27, 2008
• Sequence Number: 1
• Publication Date: August 1, 1982
• Content Type: REPORT

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Directorate of Secret
Intelligence
Chile: Challenges to the
Free-Market Model
An Intelligence Assessment
S1iR FILE CaY
iOT C! E T
E'
State Dept. review completed
Secret
ALA 82-10113
August 1982
299
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Directorate of Secret
Chile: Challenges to the
Free-Market Model
This paper was prepared by
Office of African and Latin
American Analysis. It was coordinated with the
Directorate of Operations and the National
Intelligence Council. Comments and queries are
welcome and may be directed to the Chief, South
America Division
Secret
ALA 82-10113
August 1982
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We believe the near-term outlook is still dim. We project that reduced
world demand for Chilean exports and high world interest rates will cause
real gross domestic product (GDP) to contract in 1982. Despite improve-
ments in the trade balance, openly available data on other aspects of
international payments show that the current account will remain in
deficit. Moreover, based on foreign bankers' observations, borrowing will
be more difficult to manage. One of the few positive developments this year
is that inflation is likely to remain a moderate 5 to 10 percent.
The stage is now set for growing confrontations between proponents of 25X1
more scope for private enterprise and domestic critics of economic policy.
At this juncture, Pinochet still supports the free-market philosophy, but we
believe that worsening recession might gradually change his mind. We also
believe that Pinochet could ultimately jettison some or most of his
economic policies, especially if they were jeopardizing his political position.
25X1
A gradual departure from current policy would have little immediate
impact, but the longer run consequences could be severe. Historical
experience with government intervention suggests Chile could once again
Information available as of 26 July 1982
has been used in the preparation of this report.
iii Secret
ALA 82-10113
August 1982
Chile: Challenges to the
Free-Market Model
Key Judgments Following years of chaos under Allende, the Pinochet government's
thoroughgoing economic reform program transformed Chile into a market-
oriented, free-trade economy. Diligent pursuit of these policies revitalized
the economy by curbing runaway inflation and boosting growth rates. =
The world economic downturn, however, has caused Chile to sink progres-
sively deeper into recession since mid-1981. Despite the past success of a
strategy that encouraged private initiatives, the abrupt slowdown is 25X1
intensifying public criticism-including attacks in the press-of the gov-
ernment's free-market policies. President Augusto Pinochet, concerned
about the related political costs, has relented and ordered some government
intercession. The economic team has been shaken up, and credit and
spending limits have been eased to reduce unemployment and bolster
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face stop-and-go economic performance and could encounter balance-of-
payments problems. At worst, we believe economic stagnation would
eliminate a key rationale for Pinochet's authoritarian rule, lead to political
polarization, and spark popular unrest.
The United States has a growing stake in Chile's economic progress.
Bilateral commercial ties have expanded significantly in the wake of
Chile's economic turnaround. Any substantial departure by Chile from the
free-market model would leave US businessmen vulnerable to efforts to
restrict foreign investment and reduce access to the growing Chilean
market.
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Key Judgments
Political Consolidation
1
Economic Developments in 1981
1
Economic Policy Changes Under Way
4
Signs To Watch
6
A World Bank Perspective
7
An Alternate Scenario
8
Changing Political Setting
8
The Growing Risk of Compromises
8
The Consequences
9
Implications for the United States
9
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Figure 1
Chile: Economic Indicators
Note change in scales
130
120
110 ~
,-
Gross Capital Formation Unemployment
Percent of GDP Percent
587316 B-82
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Chile: Challenges to the
Free-Market Model
The Pinochet Years
The Economic Miracle. The Pinochet government,
which took power in 1973, confronted the economic
chaos of President Salvador Allende's socialist revolu-
tion. Pinochet turned to a group of orthodox econo-
mists headed by Finance Minister Sergio de Castro.
The new economic authorities, known locally as the
"Chicago Boys," implemented throughgoing econom-
ic reforms along free-market lines. They revitalized
private markets by eliminating price, interest-rate,
and exchange controls. The government slashed state
subsidies, spending, and borrowing and sold most
nationalized firms to private investors. It instituted
free-trade policies-tariff reductions and the elimina-
tion of trade controls-to improve productive efficien-
cy. Flexible exchange rates were implemented be-
tween 1973 and mid-1979. Finally, the new
government dismantled barriers to foreign invest-
ment.
Comprehensive economic reforms along with strin-
gent austerity have revitalized the Chilean economy
since 1976 (See figure 1). De Castro's market-oriented
policies brought inflation under firm control, restored
Chile's international credit rating, and fostered a
boom in economic activity:
? Inflation was reduced from triple-digit levels to a
little over 30 percent by the end of 1980, causing
real incomes to soar.
? External solvency was restored, leading to the re-
sumption of foreign loans and direct investments.
? Real growth continued at a 7-percent average annu-
al rate during 1976-80, improving living standards.
Free-market policies have also resulted, albeit slowly,
in structural transformations necessary to improve
Chile's long-run economic performance. The elimina-
tion of subsidies and import protection shrank the
inefficient manufacturing sector. At the same time,
reduced government intervention in the economy
stimulated private commerce, transportation, and
banking. Trade reforms sparked the growth and diver-
sification of the export base. Dependence on copper
exports, for example, declined from the 80-percent
level in 1973 to less than 50 percent in 1980; Chile has
developed a sizable export trade in fruits, wine,
lumber, and pulp as well as resource-based industrial
products. Investment reforms also encouraged foreign
companies to initiate new mineral projects. Strict
fiscal and monetary discipline led to the revitalization
of private capital markets. 25X1
Political Consolidation. Chile's favorable economic
performance has played a key role in minimizing
discontent resulting from Pinochet's heavyhanded po-
litical leadership. Since seizing power in 1973, Presi-
dent Pinochet has imposed a moratorium on political
activity, and has set out to structure a political system
that will preclude a resurgence of Marxist leadership.
During and immediately after the coup, the govern-25X1
ment killed thousands of leftists, forced many more
into hiding or exile, proscribed political parties, and
clamped down on labor union activities. Since then,
by skillfully maintaining crucial military support and
exploiting the widespread political apathy resulting
from the chaos of the Allende years, Pinochet has
kept the political opposition off balance, divided, and
largely ineffective. 25X1
Pinochet maintains a tight hold on domestic politics.
He has formulated and won popular approval, in a
plebiscite, for a transition plan that effectively bans
political activity until 1989. The junta will then
nominate a president who is to be approved in a 25X1
plebiscite for an eight-year term. Only then will
congressional elections be called.
Economic Developments in 1981
Advances. Last year, de Castro's continued implemen-
tation of market-oriented reforms and free-trade poli-
cies registered new successes. Regulatory changes
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Despite Santiago's impressive successes, the 1981
slowdown has uncovered important economic weak-
nesses and trouble spots. For example, Chile's
dependence on exports of primary products underlies
its sensitivity to shifts in world demand. Minerals-
copper, iron ore, precious metals-accounted for
61 percent of total exports in 1980, 64 percent of
budget revenues, and 7 percent of GDP. Export
diversification into pulp, lumber, and fruits has
broadened the export base but done little to reduce
Chile's sensitivity to business cycles in key industrial
countries. Debt-led growth has increased Chile's vul-
nerability tofalling export earnings and rising inter-
est rates.
Government efforts to increase reliance on the private
sector have encountered setbacks. Private business-
men have been reluctant to invest in areas such as
energy, minerals, and utilities. Consequently, the
Chilean infrastructure has deteriorated in the wake
of cutbacks in public-sector investment. Moreover,
businessmen have been slow to adapt to the competi-
tive market environment. Capital formation has
lagged behind investment requirements, making the
capital stock obsolescent and heightening susceptibil-
ity to import competition.
improved the operation of the private banking system.
The government reduced personal taxes to spur indi-
vidual saving and instituted social security reforms
based on individual retirement accounts. Santiago
continued tight controls over public spending and the
profit performance of state corporations, thereby lead-
ing to its sixth successive budget surplus. Monetary
expansion was held to a mere 10 percent, sharply
down from 50 percent compared with 1980. A free
flow of imports improved productive efficiency by
stimulating competition. The government further
eased obstacles to foreign investment, and turned to
overseas firms to develop indigenous energy sources.
The current recession also highlights the political
vulnerabilities in free-market policies. Nation\vide
unemployment has now increased to more than
15 percent, compared with the 5 percent of the
Allende years. The poor and unskilled compose the
bulk of the unemployed. Consequently, the economic
downturn has accentuated a growing disparity in
wage earnings and highlighted the increasing concen-
tration of economic assets among high-income
groups.
The broader socioeconomic gains of the de Castro
years have, however, built a cushion of good will that
will not easily evaporate. The government has contin-
ued increases in the social spending programs that
were made possible by the rapid growth of 1975-81,
and this has contributed to an improvement in wel-
fare indicators, manifest in declining mortality rates
and reduced malnutrition. Moreover, Santiago re-
tains employment and food distribution programs to
cushion the worst consequences of the current
recession.
The decline in Chilean inflation accelerated. Fiscal
discipline, monetary restraint, and the fixed exchange
rate policy caused annualized inflation to fall to an
estimated 9.5 percent by the end of 1981, compared
with 31.2 percent at the end of 1980. The rapid
decline in inflation, combined with periodic wage
adjustments, contributed to a 9-percent increase in
average real wages. Living standards were also bol-
stered by a decline in the prices of food-which
accounts for 60 percent of the budget expenditures of
low-wage earners-and a boost in take-home pay for
those switching to the private pension system. Predict-
ably, the domestic savings rate also rose, contributing
to the growth of the private banking system.
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Chile: Balance of Payments
Current account balance
-1,970
-4,445
-2,600
-763
-2,455
-500
4,706
3,925
4,500
5,469
6,380
5,000
-1,320
-2,090
-2,200
113
100
100
Capital account balance
3,349
4,761
2,100
Foreign investment
304
381
200
Loan inflows
2,995
4,380
1,900
Errors and omissions
50
0
0
International reserve changes
1,379
316
-500
a Estimated.
b Projected.
Setbacks. During 1981, however, Chile also experi-
enced a series of domestic and external economic
shocks that undermined confidence in de Castro's
market-oriented policies. In May the public was shak-
en by the collapse of a large Chilean sugar conglomer-
ate because of unsound business practices. Public
concern about free-market policies was heightened
after Chilean banking authorities intervened to pre-
vent the collapse of eight major banks in November.
After five years of boom, unfavorable external devel-
opments triggered a severe recession in the second
half of 1981. Industrial sales declined an estimated
5 percent during the last quarter because of the drop
in demand for Chilean exports, falling copper prices,
high world interest rates, and intense import competi-
tion. The abrupt slowdown was accompanied by grow-
ing unemployment, increasing business failures, in-
creased domestic loan delinquencies, and bad debt.
Criticism of the government's failure to respond to
worsening economic conditions was increasingly re-
flected in newspaper editorials.
Failure to make necessary policy adjustments under-
mined Chile's payments position. The current account
deficit more than doubled to an estimated $4.4 billion
mainly because of a severe deterioration in the trade
accounts and rising interest payments on the foreign
debt. Declining demand and prices for Chilean ex-
ports and the fixed exchange rate policy caused the
trade deficit to more than triple to $2.5 billion.
Santiago resisted a currency devaluation-the ex-
change rate of 39 pesos to the dollar had been
maintained from July 1979 to June 1982-to avoid a
resurgence in inflation. The growing overvaluation of
the peso, however, undermined the competitiveness of
industrial exports and contributed to a steep rise in
imports. Moreover, concern over an expected devalua-
tion coupled with falling mineral prices also contribut-
ed to delays in new foreign investment projects,
especially in the minerals sector.
Strategy Under Fire
The recent problems of Chile's economy have trig-
gered broadbased opposition to market-oriented poli-
cies. Increased bankruptcies have heightened business
demands for renewed government subsidies, a return
to guaranteed pricing policies, and easier monetary
policies. Complaints from other quarters, such as 25X1
agricultural producers, directed against free-trade
policies appear to be part of an effort-uncoordinated
thus far-to secure higher tariffs or quotas to stem
import competition. 25X1
The extreme right-a diverse group of hardline mili-
tary, state-enterprise directors, and professionals- 25X1
continues to press for more nationalistic economic
policies. US Embassy and press reporting indicates
that the right believes that present economic policies
have resulted in:
? Excessive dependence on foreign capital.
? Dangerous private concentration of wealth.
? An erosion in the domestic industrial and agricul-
tural base.
To reverse these trends, the extreme right is seeking a
return to more state direction of the economy. This
would mean increased price controls, new business
regulations, expanded public ownership of production
facilities, and restraints on multinational corpora-
tions. 25X1
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Chile's long-quiescent political opposition has publicly
shown increasing discontent over the social conse-
quences of free-market policies. The US Embassy
reports that the moderate Christian Democrats be-
lieve the state should move to blunt the impact of the
recession, promote domestic industry, and improve
income distribution. The left-of-center Social Demo-
crats publicly stress the need for a return to a mixed
economy and increased social welfare benefits. =
The worsening recession also triggered criticism of the
private initiatives philosophy among a diverse group
of President Pinochet's supporters. The progovern-
ment press increased its editorializing about the dan-
gers of inflexible economic policies, and former Presi-
dent Alessandri called on the government in April to
modify its economic policies.
Despite growing criticism, de Castro continued his
course through the early part of this year, In Febru-
ary, for example, he denied the possibility of a peso
devaluation, stating that a currency change would
trigger strong inflationary pressure. Instead, he en-
acted new austerity measures in March. Government
spending was reduced, while income and excise taxes
were increased to balance the budget and continue the 25X1
fight against inflation.
Economic Policy Changes Under Way
De Castro's reluctance to ease restrictive policies
caused the Chilean economy to sink progressively
deeper into recession and made some policy adjust- 25X1
ments inevitable. Industrial sales, for example,
dropped an estimated 12.5 percent in the first quarter
of 1982. New business failures-an estimated 180
firms folded-and growing layoffs caused unemploy-
ment to rise above 15 percent nationwide and 19
percent in the greater Santiago area. As bad loans
mounted, the financial position of Chilean banks grew
weaker. Housing starts plunged 60 percent through
February compared with the same period last year,
while consumer sales were down 25 percent.
April, Pinochet named the head of the Central Bank,
Sergio de la Cuadra, to replace de Castro as Finance
25X1
25X1
25X1
25X1
25X1
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The Near-Term Outlook
Economic Growth
The rate of economic growth-which slowed to
5 percent in 1981-should decline again this year.
Key factors in the slowdown will be:
? A decline in industrial activity because of reduced
sales of consumer goods, cutbacks in state enter-
prise spending, a fall in new investment projects,
and stiff import competition.
? A fall in new construction because of high interest
rates and tight domestic credit.
? Flat agricultural performance because of a lack of
adequate financing and price support.
? A weak export recovery because of sluggish world
demand for primary products.
Inflation
Santiago had already reduced inflation to less than a
1 percent annual rate in the first quarter. Increased
taxes, monetary restraint, growing amounts of idle
capacity, and the moderation of real wage increases
should continue to restrain inflationary momentum
despite new government spending programs and the
recent devaluation. Chile's inflation rate probably
will range between 5 and 10 percent this year,
compared with a 9.5 percent in 1981.
Current Account
Some improvement is likely in the payments position
during 1982. We believe the current account deficit
will decline more than 40 percent to $2.6 billion.
Despite a weak export recovery, the recent devalua-
tion, a recession-induced fall in imports, and shifts in
commercial policy should enable Chile to sharply
reduce the trade deficit to $500 million. Any substan-
tial improvement in world commodity markets will
translate into a stronger-than-expected payments
recovery.
Capital Inflows
Bank lending to Chile, which has slowed this year,
should decline by about 55 percent to $1.9 billion,
while new direct investment will be halved to
$200 million. Borrowing terms-spreads on new
loans have tightened to 1.5 percentage points over
LIBOR compared to I percentage point last year-
will continue to toughen. To cover the payments gap,
Santiago will probably draw down international re-
serves by $500 million and increase short-term
borrowing.
Minister. Domestic critics of current policies reacted
favorably, while free-market proponents and Chile's
external creditors expressed concern over the policy
implications of the shift.
Economic policy adjustments have indeed followed de
Castro's departure. To ease unemployment, Pinochet
ordered in May increased public work spending;
initiation of new, low-income housing construction;
and a new government program to hire idle workers in
the depressed south. Since then, Santiago has also
taken some steps to aid domestic industries. Chile's
state copper company will provide commodity credit
loans to small producers during periods of low prices,
while state sugar beet refineries will purchase domes-
tic crops at prices above world market levels. On
1 June, the government announced measures that
lowered the cost of domestic credit and expanded
access to short-term foreign loans to ease financial
strains. In July the Central Bank took steps to lower
interest rates and help banks cope with its bad debts.
Santiago also acted to improve the payments ac-
counts. It ended the fixed exchange rate policy on
15 June, announcing an immediate 18-percent peso
devaluation and plans to further devalue the peso by
about 10 percent over the next year to improve the
competitiveness of Chilean exports. The government
had previously improved export financing terms while
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Figure 2
Chile: Improvements in Social Welfare
Mortality Rate Primary School Enrollment
Per thousand inhabitants Percent aged 5-14
587317 8-82
tightening import financing requirements. Additional-
ly, Santiago will apply countervailing duties to restrict
imports being subsidized by foreign governments. E:
Signs To Watch. De Castro's departure has triggered
growing confrontations between free-market propo-
nents and the numerous domestic critics. Finance
Minister de la Cuadra is less influential than his
predecessor. Moreover, Chile's hardline military has
gained a beachhead in policymaking. The new Econo-
my Minister, General Luis Danus, favors greater
government control over the economy,
The emergence of the military in economic policy
formulation is now triggering open speculation about
the imminent demise of the free-market model in
Chile. The US Embassy reports that the opposition
has labeled the recent devaluation as a tacit admission
of failure for the government's economic policies.
Moreover, vested interests are now lobbying for addi-
tional government intercessions on their behalf. Even
' The hardline military's philosophy envisions an enterprise econo-
my in which the state plays a key regulatory role through price
Infant Mortality Rate Government Social
Per thousand live births Expenditure Per Capita
Million 1976 US $
some staunch backers of a free-market model are now
publicly calling for increased tariff protection and
subsidized credits to pull Chile out of its economic
tailspin.
Despite these changes, Pinochet is likely to continue
to support market-oriented policies over the near
term. Even while announcing the shift in economic
ministers, he publicly reaffirmed his support for the
broad approaches of de Castro. Pinochet has left the
Central Bank and the Finance Ministry-the coun-
try's two most important economic policymaking
posts-in the hands of free-market proponents. Addi-
tionally, he personally supports the free-market model
because it has earned Chile international respect and
has visibly improved living conditions. Indeed, most of
the recent economic adjustments are not inconsistent
with the free-market philosophy. Moreover, Pinochet
almost certainly recognizes that Chile's current eco-
nomic difficulties are being mainly driven by unfavor-
able external developments-declining copper prices,
falling demand for raw materials, and high world
interest rates-rather than by basic flaws in economic
strategy.
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A worsening or prolonged recession, however, could
gradually erode presidential support for market-
oriented policies.
he is pragmatic and responsive to social pressures.
Pinochet would probably further modify the economic
model to protect his political position. Continuing
shifts from market-oriented policies would probably
be gradual, piecemeal, and with few immediate conse-
quences for Chile's near-term economic performance.
Key indicators signaling a shift from market-oriented
policies would include:
? Renewed subsidies, tax exemptions, or guaranteed
prices to aid broad sectors of domestic industry.
? Government credit to prevent business failures.
? Across-the-board tariff hikes or stringent import
controls to blunt foreign competition.
? Reintroduction of nationalistic economic policies to
restrain foreign investment in Chile's extractive
industries.
Beyond 1982
A World Bank Perspective. Any radical departure
from free-market policies would harm Chile's eco-
nomic performance beyond 1982. According to a
recent World Bank study, the continuation of market-
oriented policies would enable Chile to sustain 5- to 6-
percent real growth during the 1980s with low infla-
tion. According to the World Bank, such rapid growth
will be required to create the jobs necessary to absorb
new workers. Export diversification, increased min-
eral investments, and continued access to foreign
capital would enable Santiago to avoid payments
constraints.
The World Bank feels, however, that Santiago must
overcome serious shortcomings to realize Chile's
growth potential. Increased investment in public
works will be necessary to prevent energy or transpor-
tation bottlenecks. The government must also encour-
age industrial revitalization. Although modest
increases in capacity have taken place, Chile's indus-
trial boom has largely been accomplished through idle
capacity, better utilization of existing capital stock,
Table 3 Million US $
Except Where Noted
Chile: External Debt and
Debt Servicing Burden
External debt
7,510 9,415 13,200
Exports
4,645 5,800 5,350
Merchandise
3,763 4,706 3,925
Services
882 1,094 1,425
Debt service
1,538 2,146 2,400
International reserves a
1,938 3,123 3,214
Ratio of debt to:
Exports (percent)
161.7 162.3 246.7
GDP (percent)
29.2 34.4 45.9
Ratio of debt service to:
Exports (percent)
33.1 37.0 44.9
GDP (percent)
6.0 7.8 8.3
International Reserves
(percent)
79.4 68.7 74.7
25X1
25X1
and limited modernization of existing plants. High
domestic interest rates, tight credit, and continued
import competition will continue to undermine private
sector incentives to make necessary new investments.
25X1
The World Bank report also points out that additional
economic reforms will be needed. The indexation of
wages has restrained new job creation, and Santiago
is now moving to reduce its impact. Additionally, the
government must improve labor mobility and upgrade
worker skills. Moreover, it must continue capital 25X1
market reforms to increase the availability of long-
term investment finance and improve the access of
smaller industries to credit.
The foreign debt, says the Bank, will have to be
carefully managed to avoid external constraints to
growth. Past heavy borrowing and rising world inter-
est rates have contributed to a rapid debt buildup and
a growing servicing burden. Last year, for example,
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Chile's debt relative to its productive capacity reached
nearly 50 percent. Debt servicing, an estimated $2.4
billion in 1981, represented nearly 45 percent of
export earnings. According to the World Bank, this
ratio will rise above the 50-percent level during the
1980s. More worrisome is the increased use of short-
term credit, which will add to the debt servicing
burden and shorten debt maturities. As a result,
export shortfalls, the erosion of domestic firm repay-
ment capabilities, or tighter access to world money
markets could cause Chile serious repayment prob-
lems.
An Alternate Scenario. Despite the World Bank's
optimism for the longer term, we believe Chile is
likely to remain in recession over the next 12 months.
We believe that the rebound in world demand for
Chilean exports and reduced international interest
rates necessary for a vigorous near-term recovery
probably will not occur before next year. The recent
policy adjustments will ease economic strains but are
unlikely to promote a strong economic rebound. This
suggests that Chile will encounter difficulty in regain-
ing its past economic momentum. This poorer pros-
pect would, in turn, have important implications for
domestic politics, economic policies, and economic
performance through the mid-1980s.
Changing Political Setting. These economic prob-
lems over the longer term could give impetus to
stirrings, already evident among the long-quiescent
political opposition. The well-organized, but underfi-
nanced, Christian Democrats have recently chosen a
new party chief from the center-left to replace the late
Despite economic pressures and signs of renewed
political activism, destabilizing social violence re-
mains unlikely in the near term. We believe the
"economic miracle," the memory of the chaos of the
Allende period, and brutally effective governmental
repression have instilled political apathy in much of
the populace. In this context the Christian Democrats,
the key to any serious antigovernment activity, appear
unlikely to form a permanent united front with any
Marxist organizations, or even with the nonviolent
Socialist Convergence. Both the Christian Democrats
and the moderate socialists have announced their
intention to eschew violence.
The labor movement, so instrumental in Allende's
downfall, has been weakened by ideological splits,
successful government cooptation, and repression.
Finally, the Falklands crisis an its
implications for Chile's deadlocked negotiations with
Argentina over the Beagle Channel have diverted
public attention from domestic ills and caused a
majority of Chileans to look to the government to
defend the nation's interests.
The Growing Risk of Compromises. The inherent
longer term risk is that political pressures could
require Pinochet to modify the market model. Those
in Chile who support free-market policies are in the
minority and lack a strong political base
position
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Pinochet is well aware of this and, according to the
US Embassy, uses key military and civilian advisers
to monitor on-going political developments, popular
sentiment, and emerging social pressures. According
to the Embassy, Pinochet has modified policy when
confronted with widespread evidence that the failure
to do so poses unacceptable risks to his political
Under these circumstances, we believe two different
outcomes are possible. An alternate economic leader
may emerge who presents Pinochet with a different
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strategy for resolving Chile's current problems. We
assign a low probability to any abrupt shift in policy.
Economic policy formulation still remains in the
hands of free-market proponents and we have yet to
observe the emergence of a national leader with well-
defined economic alternatives
The more likely course is a gradual shift away from
free-market policies.
Pinochet fears that worsening recession could spark
labor demonstrations and trigger social unrest. To
prevent this, he would probably jettison parts of the
economic model over time to accommodate regime
critics and strengthen his domestic political support.
In this event, economic policymaking would become
less well orchestrated resulting in numerous inconsis-
tencies.
The Consequences. We believe that the failure to
sustain market-oriented policies over the longer term
has worrisome consequences. A gradual reversion to
"pre-Chicago" practices-industrialization spurred
by import substitution, increased government spend-
ing, restraint on foreign investment-could cause the
resurgence of many of the serious economic problems
of the pre-Pinochet era.
The political consequences of long term economic
deterioration could be severe. Stop-and-go perform-
ance leading to economic stagnation would eliminate
the economic rationale for Pinochet's authoritarian
rule and could lead to renewed political agitation. The
expanding youthful workforce, if it found employment
avenues choked off, could be susceptible to mobiliza-
tion by the opposition parties. Intensified political
action, especially if it took antigovernment overtones,
could cause Pinochet to consider postponing the tran-
sition to civilian rule and to tighten security.
If economic distress were to lead to popular unrest,
Pinochet, who does not generally yield to pressure,
might crack down on groups attempting to speed the
pace of democratization. Such action could increase
political polarization by radicalizing the moderate
labor unions, the Christian Democrats, and the
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Socialist Convergence. Faced with economic deterio-
ration and repression, these moderate elements might
be driven to an alliance with the radical left, a move
that could eventually destabilize Pinochet's govern-
Implications for the United States
The United States has a growing stake in Chile's
economic progress. Bilateral commercial ties have
expanded significantly in the wake of Chile's econom-
ic turnaround. During the late 1970s, Chile was one of
the fastest growing markets for US trade and 25X1
investments.
? US exports tripled to $1.5 billion, about a quarter of
Chile's growing import market.
? Private lending grew from negligible amounts to an
estimated $5.8 billion, nearly 60 percent of the
country's bank debt.
? US business firms have plans pending for $5 billion
in new investments, nearly 80 percent of the total
authorized by the Chilean Government since 1976.
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Any substantial shift from market-oriented policies
would damage US commercial interests. Businessmen
remain vulnerable to efforts to restrict foreign invest-
ment, especially in the minerals sector, or tougher
regulation of multinational corporations. At the same
time, higher tariffs or import controls would limit the
ability of US exporters to make further competitive
gains in the Chilean import market.
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