(SANITIZED) CHILE'S EMERGING ECONOMIC PROBLEMS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700010090-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 10
• Document Creation Date: December 22, 2016
• Document Release Date: January 28, 2010
• Sequence Number: 90
• Publication Date: July 1, 1971
• Content Type: IM

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38
Secret
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Chile's Emerging Economic Problems
DSB FILE COPY
RETURN TO 1E-61
Secret
ER IM 71-138
July 1971
Copy No. 67
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WARNING
This document contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 793 and 704, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
July 1971
INTELLIGENCE MEMORANDUM
CHILE'S EMERGING ECONOMIC PROBLEMS
Introduction
1. During Allende's first eight months as President, Chilean economic
policy has concentrated on the immediate objective of building political
support. Various steps have been taken to this end, notwithstanding their
eventual economic consequences. Chile is beginning, for example, to
encounter balance-of-payments problems because of sharply increased
consumer demand, disruptions of output resulting from nationalization, and
the negative reaction of Chile's traditional creditors. The nation had a large
cushion of foreign reserves when Allende took office, but they are being
depleted rapidly. Allende eventually will be forced to take politically
unpopular actions to restrict consumer demand, which could have serious
political implications - particularly if he has failed to consolidate his
position. This memorandum discusses the economy's developing problems
and short-term prospects and assesses the implications for Allende's future.
Discussion
Recent Domestic Economic Trends
2. Allende's policies have largely succeeded in achieving their
immediate objectives of reactivating the economy and massively
redistributing income, thereby boosting the administration's popular
support. A strict price freeze and wage increases ranging from 35% to 45%
for most employees have sharply increased consumer demand from its initial
post-election slump. Although inflationary pressures are mounting, Allende
thus far has held the increase in consumer prices to less than half the rate
of recent years (see Figure 1). Because factory owners were reluctant to
Note: This memorandum was prepared by the Office of Economic
Research and coordinated within the Directorate of Intelligence.
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CHILE: Cost of Living Indexes
December of the Previous Year=100
Figure 1
hire workers that they might not be able to discharge later, unemployment
remained fairly high during Allende's first months in office. But the
consumer boom and large public spending program recently have sharply
reduced the ranks of the unemployed.
3. Fiscal policy has played a large part in stimulating production
and furthering income redistribution. The 1971 budget projects a 60%
increase in expenditures in nominal terms. Government revenues, however,
are expected to stagnate because of production problems, lower prices, and
rising costs in the copper industry and severely depressed profit margins
in other industries. As a result, the 1971 deficit probably will equal 25%-30%
of expenditures, or 7%-8% of gross national product. Thus far, Allende's
budget deficit has been financed almost entirely by Central Bank loans to
the public sector -- that is, by printing money. The cumulative amount
of these loans has increased about tenfold since Allende was elected, and
the money supply has jumped by about 70% (see Figure 2).
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CHILE: Trends in Money Supply, Central Bank Credit Figure 2
to the Public Sector, and Consumer Prices
Dec 1967=100
Billion Escudos
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4. Allende has emphasized rapid expropriation of the remaining large
farms and, until recently, even tacitly encouraged peasant takeovers of large
and medium-sized holdings. The administration announced that it reached
its goal of expropriating 1,000 farms several weeks before the scheduled
date of 30 June 1971, when a new agricultural year began. Plantings of
winter wheat re orte:dly are down sharply this year
Since the seizures also have had an
unfavorable political impact, Allende now publicly opposes them. While
expropriation has been depressing marketed farm output, rising incomes -
especially for lower income groups - have boosted food demand by at least
10%-15%.
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5. Nationalization of industrial and commercial firms is destroying
investment incentives and disrupting production in many firms, partly by
contributing to poor worker discipline. The effects are most pronounced
in the copper industry, but other sectors are also being affected. A major
stratagem in Allende's takeover of manufacturing firms has been to use
labor disputes as a pretext for appointing government managers, under a
1945 statute that prohibits discharging workers. This policy has led to
widespread absenteeism, with up to half of the workers reportedly failing
to appear in some plants on either Mondays or Tuesdays. In an attempt
to control these problems, Allende's Popular Unity coalition has established
workers' "vigilance" committees in most factories to report on and
intimidate those responsible for production losses.
6. Socialization of the economy - already characterized by extensive
state control - has progressed notably under Allende. The final step in
fully nationalizing the large US-owned copper mines is now completed,
although compensation remain to be determined. The state has bought
control of most private banks and taken over almost all the large textile
firms and several steel fabricators and gas distributors. In addition, it has
nationalized Bethlehem Steel Company's iron ore properties and the nitrate
mines owned by Anglo-Lantaro. Allende has used various techniques in the
takeovers, including the securing of a constitutional amendment to facilitate
copper nationalization, direct negotiations in the case of the iron and nitrate
mines, purchases of bank shares (after making continued operations
unprofitable for the owners), and appointment of government managers for
firms in. such industries as textiles and cement. Chile has taken control
of something like one-third of the private industry remaining in 1970.
Impact on the Balance of Payments
7. The massive increase in consumer demand resulting from Allende's
policies is only gradually being reflected in increased imports, since
considerable stocks of finished goods, components, and raw materials were
accumulated during the post-election slump in sales. Although imports of
such goods have not yet increased appreciably, higher real incomes already
have been translated into larger foodstuff imports. During January-April
1971, imports of industrial raw materials and fuel were only about 8%
higher than in the corresponding 1970 period, but foodstuff imports more
than doubled. Because capital goods imports fell, total imports were only
10% higher than a year earlier.
8. Export earnings are down considerably from 1970, reflecting both
lower copper prices and production problems in the large copper mines.
The near-completion of copper expansion programs last year was expected
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at one time to permit a rise of almost 40% in copper output and export
volume in 1971. J Although production at the new Exotica and Andina
mines has begun, total Chilean output so far is up only about 8% above
the 1970 level, inasmuch as output has declined at the other three large
mines. Contrary to Chile's expectations, increased export volume has not
offset the decline in cop?er prices.
9. At the same time, traditional sources of foreign credit and
investment are rapidly drying up. Short-term and medium-term credit
outstanding from US commercial banks has fallen from $225 million to
less than $165 million since the Presidential election last September, and
US companies not yet affected by nationalization are repatriating funds
as rapidly as possible. Chile is finding it very difficult to replace US
investment and credit with funds from other Western countries, partly
because heavy borrowing by past administrations has given it one of Latin
America's- largest long-term foreign debts. The total outstanding now
approximates $2.4 billion, and debt service obligations (principal and
interest) amount to about $300 million this year. Since a sizable portion
of this debt is held by West European interests, they may be hesitant to
increase the amount at risk. The net result of heavy debt service payments,
lower exports, higher imports, and the drying up of foreign bank credit
has been a drop in Chile's net international reserves from $345 million
to some $200-$225 million during the first six months of 1971, despite
receipt of $17 million in special drawing rights from the International
Monetary Fund.
Short-Term Prospects
Remainder of 1971
10. Although problems are looming, Allende and his extreme leftist
coalition probably will be able to continue their politically expedient
economic policies during the next few months. In several respects, the
regime may well be able to point to a favorable record of accomplishment
for the year. The adverse effect of agrarian reform on farm output will
not be fully apparent until the harvest begins in early 1972, and there
will be gains in mining and manufacturing output because of recent additions
to copper production capacity and the strong demand for consumer goods.
Chances thus seem good that the real economic growth rate in 1971 will
exceed the 4% average of the past four years. Successful use of price controls
and expanded imports to curb inflation so far this year suggests that the
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cost-of-living will rise less than in recent years, despite the large wage
increases and massive increase in the money supply.
11. The main cost of continuing present economic policies for several
more months will be a further marked drop in foreign reserves - if copper
production remains well below capacity and there is no sustained rise in
prices as -a result of an extended strike in the US industry. Imports are
likely to rise by 15%-20% this year because of expanded food purchases,
and export earnings so far are down because copper prices have averaged
less than 50 cents a pound, compared with 64 cents in 1970. Under these
circumstances, the trade deficit seems likely to reach $100-$200 million.
Even if remittances by the copper companies (including compensation for
final nationalization) are very small, as seems likely, service transactions
stand to add another $100 million or so to the deficit. A substantial loss
of reserves thus is in prospect unless the capital account balance is favorable.
12. Everything considered, however, Chile probably will have a net
capital outflow of some $50-$100 million in 1971. The backlog of about
$400 million in development credits from Free World nations and
international agencies is an element of strength and might permit drawings
of as much as $200 million this year. But such receipts would merely balance
the scheduled debt amortization payments, which Chile is likely to meet
during at least most of 1971 -although rescheduling may be sought after
reserves deteriorate further. In the case of short-term capital, a sizable net
outflow seems likely, since US commercial banks anticipate further cutbacks
in credit lines to Chile. It is doubtful that these losses can be fully offset
by drawings on credits from Communist countries or by West European
and Japanese loans and investments. With a 1971 balance-of-payments
deficit of some $250 million - the smallest amount that can reasonably
be expected barring policy changes or strengthening copper prices - net
foreign reserves would drop to roughly $100 million. Such reserves (which
would equal only one month's purchases of goods and services) probably
are close to the minimum needed to conduct normal commercial relations.
Next Year
13. Sometime toward the end of 1971 or early in 1972, Chile
probably will have to start living more in accordance with its means. If
accelerating inflation, black markets, and some form of rationing are to
be avoided next year, the government will need to take strong actions such
as severely restricting wage increases, raising taxes, and curbing credit
expansion. Next year could also see the beginning of a major reallocation
of resources from private consumption to investment if balance-of-payments
constraints and bottlenecks in production capacity are sufficiently severe
and if the regime subscribes to the usual Communist formula for economic
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development. Corrective measures will be difficult to carry out, however,
and will be politically unpopular. The existing dissension among the
Allende-led forces may increase as the pleasure of attacking US business
and Chile's economic elite gives way to formulating long-term programs
for the new "socialist" Chile. Even if economic policy fails to reach such
a stage but consists largely of reacting to economic strains, Allende may
have trouble building a consensus for action.
14. Unless copper prices rise dramatically or copper production
problems are solved rapidly, Chile probably will be forced to curtaii imports
sometime during the next several months - either through direct controls
or substantial devaluation of the escudo, which is now grossly overvalued.
Demand for imported raw materials and manufactured goods will soon rise
markedly becau:., the stocks accumulated during late 1970 are now largely
exhausted. At the same time, Chile probably will need a further large
increase in food imports because agrarian reform and peasant takeovers
probably will cause a poor 1972 harvest.
15. The Minister of Economics has stated that following the present
period of "reactivation," Chile will enter a period of "accumulation" --
that is, heavy expenditures for investment such as are found in other
Communist countries. Allende's original timetable called for the reactivation
period to last until the "Revolution became irreversible," which means until
effective political opposition had been eliminated. The reactivation phase
is supposed to end in about April 1972, but the rapid depletion of foreign
reserves may force earlier action despite the political risks involved.
16. If the economic situation deteriorates seriously, the Allende
regime probally will turn to Communist countries for aid to ease problems
and minimize the political backlash that basic corrective measures would
provoke. We believe
that some assistance would be forthcoming from these
countries, although it is doubtful that the USSR -- Chile's most likely
Communist benefactor - would supply aid to the extent envisioned by the
local Communists. Against the backdrop of continuing heavy support for
Cuba, Moscow will continue to move carefully in backing the world's first
popularly elected Marxist government and, in fact, has urged Allende to
proceed cautiously in implementing his reforms. Even if unwilling to provide
a large amount of convertible currency, Communist countries could assist
Chile by supplying goods normally purchased in Western markets - such
as petroleum, iron and stee?, and certain foodstuffs -? as well as by extending
the customary economic development loans. Such assistance, however,
probably would help only partly to meet Chile's pressing need for large
amounts of relatively united capital.
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