THE CHILEAN ECONOMY: TRENDS UNDER FREI AND PROSPECTS FOR 1969-70

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001600020055-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 34
• Document Creation Date: December 22, 2016
• Document Release Date: May 17, 2010
• Sequence Number: 55
• Publication Date: April 1, 1969
• Content Type: IM

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DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
The Chilean Economy: Trends Under Frei
and Prospects for 1969-70
ER .IM 69-53
April 1969
Copy No. 66
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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 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
:!eipt by an unauthorized person is prohibited by law.
GROUP I
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d.clai.ifcation
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
April 1969
INTELLIGENCE MEMORANDUM
The Chilean Economy:
Trends Under Frei and Prospects for 1969-70
Summary
In spite of large inflows of foreign aid and
favorable export markets, the conditions for
economic growth in Chile are less favorable now
than in 1964, when the Frei administration took
office. The failure to do better economically is
largely the result of the high priority given to
social reforms and of the problems created by
political fragmentation, congressional irresponsi-
bility, and shortcomings in Frei's leadership.
Chile has made important social gains under Frei,
including:
a large increase in real incomes
of the poorer classes;
a considerable expansion of social
services, especially education; and
a major start on a comprehensive
program of agrarian reform.
Whatever their potential economic benefits,
these changes have been so rapid and costly that
they have had detrimental short-term effects on
the health of the economy. To pay for them, Chile
used up most of the proceeds from the increase in
foreign economic assistance and the exceptional
Note: This memorandum was produced soZeZy by CIA.
It was prepared by the Office of Economic Research
and was coordinated with the Office of Current
Intelligence.
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rise in earnings from copper. In addition, --n-
comes had to be diverted not only from the wealthy
classes but also from private businesses and farms.
Business confidence and profit expectations were
in general impaired, and land reform in particular
had disruptive effects on agricultural output.
Even though tax collections improved substantially,
deficit financing of government expenditures was
necessary, and the growth of public investment
eventually had to be sharply reduced. In conse-
quence, economic trends turned unfavorable:
gross domestic product (GPD) per
capita grew moderately fast in
1965-66 but declined in 1967-68;
the pace of inflation first slowed
but then speeded up, reaching a
rate of 28 percent in 1968; and
private investment has declined
since 1964, and total investment
has leveled off.
In 1969-70 the Chilean government cannot expect
additional revenues from the copper industry, and
total output per capita probably will decline be-
cause of the current severe drought and the squeeze
on private business. A continuation of the rapid
social gains of the past few years will therefore
not be possible, and real wages may even decline
before the presidential election in September 1970.
During Frei's first two years in office, con-
ditions were strongly favorable to the
use of
fiscal and monetary policies to achieve
both
price
stability and economic growth. A sharp
rise
in
copper prices and the continuation of a
high
level
of foreign aid brought a dramatic improvement
in
Chile's balance of payments. At the same time, the
government's revenues rose rapidly in response to
a basic tax reform and the rise in copper prices.
The administration initiated a suitable stabiliza-
tion program and instituted needed reforms in foreign
trade and banking, as well as taxation. These re-
forms were designed to reduce both the rate of in-
flation and the detrimental effects of inflation
on the allocation of resources.
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This promising beginning was undermined mainly by
failure to hold wage increases to reasonable levels.
Ignoring the administration's guidelines, the Con-
gress granted increases that allowed real wages in
the public sector to rise by some 40 percent during
1965-67. Even with a slowdown in the growth of
public investment, budget deficits grew, and con-
tinued government borrowing from the banking system
was necessary. Because of the power of the labor
unions and the poor example offered by the public
sector, private enterprise was forced to give its
workers even more generous wage increases.
The fall in private investment contributed to
the slowdown in economic growth during 1967-68.
Rising taxes and wages have given costs a continu-
ing strong push and have squeezed the profits of
agricultural and industrial producers, most of
whose prices are controlled. The cut in profits
has been exacerbated by a substantial shortage of
credit for the private sector as the government
absorbed a large share of available credit under
stabilization ceilings. Perhaps most important,
investor confidence has been severely eroded by
four years of uncertainty concerning land reform
policy and by the growing threats against private
industry by the leftist element of the Christian
Democratic Party (PDC) as well as by Marxist par-
ties.
Chile's economic prospects for 1969-70 are
decidedly unfavorable. Already caught in a
quandary of economic stagnation with rapid infla-
tion, the Frei administration faces increasing
economic difficulties and reduced capabilities to
deal with them. The current drought will have
adverse effects on output and employment. As a
result, the administration will be even more
tempted than in the past to follow expansionary
fiscal and monetary policies. Moreover, pressures
for increased government spending on wages and
welfare almost certainly will intensify as the
presidential election approaches. Budget and
trade deficits are expected to grow in 1969 and
1970 and will be even larger if copper prices de-
cline. A record level of foreign aid probably
will cover the bulk of these deficits in 1969, but
receipts of aid may decline in 1970. The govern-
ment thus might have to restrict imports and either
cut plans for government spending or resort to
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inflationary financing of a substantial part of
the budget deficit.
Under these circumstances, business confi-
dence -- and private investment -- probably will
reach a new low during 1969-70, particularly since
the powerful leftist faction of the PDC will be
competing with other leftist forces in calling
for elimination of capitalism during the next
presidential term. Increased pre-election clamor
for nationalization of foreign companies probably
will not prevent continuation of the large invest-
ment program by the US copper companies because
these investments are guaranteed by the US govern-
ment; it could, however, further discourage other
foreign investments. Government spending probably
will be increased in an effort to stimulate the
growth of output and maintain employment, even
though accelerated inflation will result. Letting
the rate of inflation climb to 40 or 50 percent
annually would be politically risky and economically
irresponsible, but the Frei administration may find
it the least unpalatable alternative available.
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Introduction
1. Eduardo Frei Montalva and his Christian
Democratic Party (PDC) came to power in late 1964
on a platform of a "Revolution in Liberty" for
Chile. In essence, the platform was a pledge tc
achieve through democratic institutions a far-
reaching and dynamic program of socio-economic re-
form. The new administration faced a number of
longstanding economic problems -- inflation,
balance-of-payments difficulties, large government
deficits, a rate of growth below the nation's
capability, and an inequitable distribution of the
national income. The Frei administration, however,
has had an advantage over preceding governments in
its capacity to attack these problems, for two
reasons. First, Frei's election to the presidency
by an absolute majority of the vote and his party's
acquisition, in the 1965 congressional elections,
of a majority of the seats in the lower house and
a strong minority in the Senate should have reduced
some of the political constraints on economic
action confronted by earlier coalition governments.
Second, world market prices for copper -- the source
of the bulk of Chile's export earnings and an
important share of tax receipts -- rose by almost
50 percent during the administration's first two
years in power and have remained high. Although
earnings from copper rose substantially, Chile
continued to receive large amounts of foreign aid.
Drawings on external loans have averaged about
$250 million annually under Frei.
The Economic Record Through 1968
Growth and Distribution of National Income
2. Although Chile has been favored by high
levels of export earnings and foreign aid, the
rate of economic growth during the past four years
has been less than the average for Latin America
and has been no better than that achieved under the
preceding, conservative government of Jorge
Alessandri (1958-64). Chile's rate of growth has
been held down by Frei's pursuit of such social
objectives as agrarian reform and more equitable
distribution of income. Some of the costs of
these social programs were willingly assumed by
the administration.. Others have been thrust upon
it because of the rising tide of economic demands
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and political pressures that its "revolutionary"
program unleashed.
3. Annual increases in GDP averaged roughly
4 percent during Frei's first four years, or some-
what less than 2 percent per capita. Thanks to a
sharp rise in consumer demand and public invest-
ment, GDP grew by 5 percent in 1965 and almost 7
percent in 1966. Strike difficulties in the mining
sector and a slowdown in manufacturing and construc-
tion activities brought an early end to the boom
period, however. The rate of economic growth in
1967 fell to about 2 percent, and the final results
for 1968 are expected to show little if any improve-
ment over that low rate. By comparison, economic'
growth during the last four years of the Alessandri
administration averaged about 5 percent annually.
This is the only period for which fully comparable
data are available, but it is apparent that, under
both Alessandri and Frei, the Chilean economy sur-
passed the long-term growth rate of about 3.5 per-
cent that was achieved from 1940 to 1960.
4. During Frei's first two years, Chile's
gross domestic income (defined as GDP in real
terms plus changes in the terms of trade) grew more
rapidly than its GDP because of rising world prices
for copper. Gross domestic income expanded by more
than 17 percent during these two years, compared
with the 12-percent increase in GDP. Expansion
in income adhered more closely to the rate of
growth in total output during 1967-68, as copper
prices leveled off.
5. Under the Fvei administration, private
consumption has increased somewhat more rapidly
than GDP and much more rapidly than investment
(see the chart). Underlying the rise in private
consumption was a large increase in wage income,
which made up 54 percent of GDP in 1967, compared
with 47 percent in 1964. Lower income groups have
experienced gains in their living standards as a
result of both the substantial increase in real
wages and the expansion in social services under
the Frei administration. While the poorest workers
have benefited from these policies, organized labor
probably has gained proportionately more, since
the unions have had the power to obtain even larger
raises in wages. Other people who supported the
PDC in the 1964 election -- from among such groups
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Index: 1964=100
GDP per Capita'
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'Gross Fixed Investment
as owners of large and middle-sized farms, private
businessmen, and the wealthy class in general --
have lost ground since Frei's advent. Even many of
those who have gained the most probably expected
more of he new government or feel that they would
have done better under an openly Marxist government.
The losers, on the other hand, almost certainly
attribute their misfortune to the policies of the
Frei administration.
6. The Frei government has dramatically in-
creased the share of resources allocated to the
public sector. Public consumption rose much faster
in volume than GDP until 1967, when the continued
rapid increase in the public wage bill restrained
new hirings and goods purchases. Because increases
in public investment were partly offset by reductions
in private investment, the grr--th of total investment
lagged well behind that of (C' . During the period the
public sector has become far more important than
the private sector in capital formation. This
change is reflected partly in the increased role of
public entities as direct investors and partly in
the growing tendency of private investments to be
financed with funds obtained from the public sector.
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Public investment expenditures, including government
loans for private investment in specific industrial
projects, rose from 48 percent of total gross
domestic investment in 1963 (the last normal, pre-
election year) to 71 percent in 1967. During the
same period, the public sector's direct expendi-
tures for fixed investment rose from 40 to 55 per-
cent of total fixed investment.
Private Capital in a Mixed Economy
7. The Frei government's objective of increas-
ing the public sector's importance in the economy
thus has discouraged private investment and led to a
reduction in share of total investment in GDP.*
The PDC's economic policy assigned to the govern-
ment a leading role in assuring an increased flow
of funds into the development of selected indus-
tries as well as into agrarian reform, education,
housing, and other programs designed to improve
the welfare of lower income groups. With some
justification, the PDC held that the flow of pri-
vate resources into these areas had been inadequate
and needed to be supplemented by the government.
President Frei and his more conservative supporters
within the party recognized the continued importance
of private investors, however, and tried to encourage
their participation in the task of economic de-
velopment despite the government's larger economic
role.
8. In practice, however, government policies
have discouraged private investment. Ever-
increasing financial demands from both government
and labor have cut severely into private profits
and dampened profit expectations. The terms of
' The ratio of gross fixed investment to GDP dur-
ing the first three years of the current adminis-
tration averaged about 15 percent, compared with
an average of 17 percent during the last four years
of the AZessandri government. Previous estimates
of national income had indicated an average ratio
of investment to GDP of 12 to 13 percent for the
1960'x. During the last two years, however.; `
??
Chilean Planning Office has completely revises the
statistics for the period 1960 to 1967. Although
the new accounts probably are an improvement over
earlier estimates, basic data still are fairly un-
reliabZe, particularly in regard to private invest-
ment and personal consumption.
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trade for agriculture improved somewhat during 1965
and early 1966 (though the gain was partly offset
by rapidly rising labor costs), but they began to
deteriorate again by late 1966. During the past
two years, real agricultural prices continued their
decline, and the profit squeeze tightened because
farmers bore the brunt of administration efforts
to stem the accelerating rise in the cost of living.
In private business activities outside of agricul-
ture, savings have declined (in real terms) through-
out the period. Profits have been squeezed because
prices were controlled while costs were rising
rapidly as a result of substantial increases in
taxes and wage raises far in excess of productivity
gains.
9. Industrial expansion also has been impeded
by a severe tightening of credit, except for a few
projects being promoted by the government. Bank
credit to the private sector has been restricted
within the limits established by the government's
borrowing needs on the one hand and the ceiling
imposed by the International Monetary Fund (IMF)
on overall credit expansion on the other. During
1965 and 1966, manufacturers generally were able
to respond quickly to the increase in consumer
demand accompanying the rise in wages and thus to
partially offset narrowing profit margins through
increased sales volume. Some manufacturing firms
had reached their capacity levels by 1967, however,
and subsequently were unable to expand operations
because of the credit squeeze. Other industries
have encountered more complex problems since 1966
because the slackening in the overall rate of eco-
nomic growth, a substantial decline in construction
activity, and marked shifts in consumer preferences
have reduced effective demand for their products.
These firms have been confronted simultaneously
with declining sales, rising costs, and restricted
credit. Many industries also have been increasingly
affected by strikes, which caused the loss of 2 mil-
lion man-days of work in 1967 and 4/ million man-days
in 1968.
10. Investor confidence has been further eroded
by uncertainties concerning land reform policy and
by repeated threats against private industry (in-
cluding the threat of nationalization) that have
emanated from the more leftist elements within the
PDC as well as from openly Marxist forces. Private
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Revenues and Expenditures
of the Consolidated Public Sector
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investments have been restricted mainly to a few
industries (such as petrochemicals, paper, cellu-
lose, and steel) to which the government is heavily
committed and has been willing to provide capital.
Thus political uncertainties and the squeeze on
profits and credit have relegated private capital
to a less important role than the Frei faction of
the ruling party had initially intended.
11. The interest of potential foreign investors
apparently also has been dampened by the changed
environment for private enterprise. A World Bank
mission to Chile in the summer of 1968 found little
private foreign capital entering the country other
than for the copper companies' expansion program
(insured under the US investment guaranty program)
and a few major investment projects arranged some
time ago.
Fiscal Control and Public In'Pestment
12. The Frei government, favored by a rapid
growth of revenues, has succeeded in reducing the
ratio of the budget deficit to total expenditures
but not the amount of the deficit in real terms
(see Table 1). The ratio of the budget deficit
Million 1967 Escudos
Deficit as a
Percent of
Revenues tures Deficit Expenditures
164 7,267 8,367 1,100 13.1
1965 8,849 10,246 1,397 13.6
1966 10,592 11,811 1,219 10.3
1967 12,344 13,393 1,049 7.8
1968. (Pro-
visional) 13,259 14,518 1,259 8.7
Expendi-
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to total expenditures of the public sector declined
from about 13 percent in 1964 to 8 percent in 1967
and about 9 percent in 1968. The deficit in 168
still equaled about one-third of public investment
expenditures compared with about one-half in 1964.
13. During 1965-66, revenues grew in real terms
by almost 60 percent for the central government
and by more than 45 percent for the public sector
as a whole. Revenue yields from the rapidly rising
profits of the copper companies doubled during this
period and provided about 17 percent of central
government revenues in 1966. Extension of the tax
reform initiated under the previous administration
brought a 55-percent increase in other income taxes
and property taxes during Frei's first two years in
office. Indirect taxes grew by almost 50 percent
during this period because of an improvement in
the system of tax collection as well as the increase
in economic activity. During 1967-68, economic
growth slowed and copper prices leveled off, holding
the annual increases in central government revenues
to only 10 percent in real terms, compared with the
26-percent annual average in 1965-66. By 1967,
taxes (including social security contributions)
had increased to more than 30 percent of GDP -- a
high ratio by almost any standard.
14. The Frei administration allowed the total
expenditures of the public sector to rise by about
75 percent in real terms during 1965-68 in sharp
contrast to the moderate initial increases and
subsequent declines in expenditures during the
preceding four years. As a ratio of GDP, total
public spending rose from 35 percent in 1964 to
about 45 percent in 1968. The difference in the
growth of current expenditures during the two
periods was even more pronounced, as shown in the
chart. Annual increases in public investment
expenditure dropped from an average of 20 percent
in 1965-66 to about 10 percent in 1967 and 5 percent
or less in 1968 -- thereby providing an element of
budgetary restraint during the past two years.
For the period as a whole, public investment rose
by about two-thirds while private investment fell.
15. Under Frei, public investment has continued
to be concentrated on transportation and electric
power facilities and on housing, education, and
oth-r social welfare projects. During 1965-67, less
than one-sixth of public investment (including
publicly financed private investment expenditure)
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Trends in Public Sector Expenditures and GDP
Index: 1960 =100
200 1
190 1
leL
170
-6o
Capital Expenditures
Expenditures
76081 4-69 CIA
Index: 1964 =loo
1964 1964
*Provlslonel
was devoted to industrial and agricultural projects.
Government investment spending thus has done little
to offset the depressing effect of the administra-
tion's economic policies on private investment in
these fields.
16. In its program for 196C, the Frei adminis-
tration launched a courageous, but belated, battle
for a more restrictive fiscal policy. The most
important expansionary forces behind the rapid
rise in current expenditures by the central govern-
ment during 1965-67 were a 53-percent increase in
the real wage bill and a 51-percent increase in
real terms in current transfers to decentralized
agencies (in part necessitated by the increase in
their wage bills). In view of the increasing in-
flation and decreasing rate of growth, the need
for greater restraints on current expenditures was
evident. Frei therefore introduced into Congress
a wage readjustment bill zox public employees that
would hold increases in cosh income in 1968 to 75
percent of the cost-of-living rise in the preceding
year and pay the other 25 percent in bonds issued
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against a newly created national investment fund.
By this time, however, the President not only had
little influence among the opposition in the Con-
gress but also had lost control over a large portion
of his own party. The "compromise" bill that
finally emerged from the Congress after six months'
& lay and thP'resignation of two Finance Ministers
contained none of the savings features of the
original and permitted an average increase of about
38 percent in wages -- far in excess of the 22-
percent rise in the cost of living the previous
year.
17. The sharp increase in the budget deficit
over the level originally planned for 1968 was
covered partially by requiring "prepayment" of
corporate and personal income taxes -- in effect,
a forced loan (to be repaid in 1970) which was
extended to include the US copper companies as
well as Chilean taxpayers. in addition, the
administration successfully negotiated for resump-
tion of budgetary support from the United States in
the form of a $20 million program loan drawn on
during the latter half of 1968. *)espite these
additional. sources of revenue and the trimming of
investment expenditures, deficit financing through
domestic borrowing continued to be necessary in
1968.
Agricultural Development and Reform*
18. Although Frei's ambitious agrarian reform
program has partly achieved its social and ''litical
objectives, it has not been successful thus ar
from an economic standpoint. It is still too early
to judge whether the program ultimately will con-
tribute to the solution of Chile's longstanding
agricultural problems. It is clear, however, that
had the program been motivated predominantly by
economic considerations, less costly and more ex-
peditious ways of strengthening production incen-
tives, encouraging investment, utilizing land more
effectively, and improving farm technology would
have been adopted. Chile continues to be increas-
ihgly dependent on imports of foodstuffs, about
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three-fourths of which could be produced domesti-
cally if the agricultural sector were more effi-
cient. Net imports of food had risen to about
$120 million annually before the current drought
became a factor contributing to the inadequacy of
domestic production.
19. The Frei administration had hoped to mini-
mize the adverse impact of land reform on the
existing landowners by establishing the guidelines
and schedule for expropriation promptly and clearly
and by substantially improving terms of trade for
agricultural producers. The new, stronger land
reform law desired by Frei took more than two years
to pass through Congress, however, meeting opposi-
tion from both rightist and leftist forces. During
the 18 months since its enactment, conflict within
Frei's own party concerning the pace and goals of
reform has deepened the feeling of uncertainty
among private landowners. During its first two
years, the administration did succeed in increasing
agricultural prices in real terms*; in 1966 they
averaged 13 percent above their 1964 level. Since
late 1966, however, these prices have been declining.
By the end of 1968 they had slipped back to about
the 1964 level. The costs of agricultural production
have climbed steeply throughout the period since 1964.
Wage costs in particular have soared, largely be-
cause of the success of the unionization movement
sponsored by the govert.ment. Although precise data
are lacking, agricultural production apparently is
even less profitable now than it was prior to the
Frei administration, and private investment has
fallen.
20. At a heavy cost in money and some disrup-
tion of agricultural activity, about 4 percent of
the total land in farms was acquired for redistri-
bution between the end of 1964 and mid-1968. About
four-fifths of this land has been incorporated into
some 270 cooperative settlements managed by the
Agrarian Reform Corporation (CORA). Although less
than half of the land acquired thus far was expro-
priated, involvement of ?adical members of the PDC
in the administration of the reform has made it
more damaging economically and more abrasive
socially than it needed to be. Carried out in
' Prices received by producers -of agricultural
products, def.ated by the increase in the consumer
price index.
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the spirit: of a "revolution in the countryside,"
the program probably he.!; depressed output in some
areas most heavily affected by agrarian reform
activities. It has not, however, prevented
moderate gains in output for the country as a
whole. All of the gain in total output has come
from sharply increased 1,:4.vestock output. Crop
production, which has been more directly affected
by land redistribution and lower prices, has de-
clined since 1964.
21. During the first two and one-half years of
the Frei administration, CORA acted under the land
reform law of 1962 and acquired 1 million hectares
for redistribution -- about half of it from publicly
owned lands. Since enactment of the new land reform
law in July 1967, almost all of the land acquired
has been expropriated. By 31 May 1968, CORA's
acquisitions amounted to some 1,250,000 hectares,
including almost 15 percent of Chile's total irri-
gated area and 30 percent of the irrigated land in
the richest agricultural area, in the provinces
surrounding Santiago.
22. The original target for land redistribu-
tion was to settle 100,000 families during 1965-70.
but in 1967 the goal was revised downward to 60,000
families. By mid-1968, only about 9,000 families
had been settled. In view of the recent rate of
progress, settlement of 35,000 families by 1970
would be a more realistic goal. The program
apparently is being hindered mainly by financial
difficulties. Total government expenditures on
agrarian reform are not known, but reported public
investment expenditures channeled through CORA
(which may include large amounts of current expendi-
ture) have amounted to almost $100 million during
the past four years. These expenditures by CORA
have now increased to about 5 percent of total
public investment. According to CORA's own esti-
mates, the costs for resettlement average $11,000
per family.
23. Much controversy has developed in Chile
concerning the net costs of the land reform and
the viability of the new cooperative settlement9,
in part because CORA has refused to make public the
balance sheets of the newly organized farms. It
is clear that the land reform costs are far in
excess of the government's original estimates.
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Even the reduced goal adopted in 1967 places a
significant financial burden on the government.
24. Landholders and other Chileans holding
traditional views regarding property rights are
greatly disturbed by the confiscatory nature of
the land reform effort. Expropriated properties
are valued at their assessed value for tax pur-
poses, which generally amounts to only about 50
percent or less of their market value. Cash pay-
ments for the expropriated land are small -- only
1 to 10 percent of the price paid. The remainder
is paid in 25- to 30-year self-liquidating bonds
that carry a 3 percent interest rate and will be
adjusted in value periodically to reflect 70 per-
cent of the change in the cost of living.
Other Social Welfare Programs
25. The Frei administration has initiated an
8- to 10-year program to reform the public educa-
tion system and has given it high priority. About
6 to 7 percent of public investment expenditures
are being channeled into construction of school
facilities (compared with an average of 4 percent
during 1961-64), and educational expenditures
represent about one-fifth of the government's total
current expenditures. The US Agency for Interna-
tional Development (AID) has provided two loans
totaling $26.3 million for education and has pro-
posed additional loans for education of at least
$60 million during 1968-71. Substantial progress
already has been made in expanding school facilities
and, in particular, in increasing educational oppor-
tunities for low-income groups while improving the
quality of their instruction.
26. Although housing continues to absorb some
25 percent of total public investment spending,
achievements have been less satisfactory in this
field than in education. During the 1964 campaign,
Frei promised a housing program of 360,000 new
starts by 1970, or an average of 60,000 annually,
compared with an average of 30,000 annually during
the Alessandri administration. At the end of three
years, only about one-third of the goal had been
met, and the Frei administration announced a new
target for low-income housing. The revised program
embraces new starts on the construction of permanent
houses and temporary dwellings and the mere provision
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of urban sites -- some with construction materials
to he used on a self-help arrangement. On this
basis, the administration may well be able to
claim overfulfillment of its targets, particularly
in view of the fact that the Housing Ministry
since 1967 has been able to expropriate urban
land at a fraction of its market value.
27. The Frei administration is committed to
the expansion of public health care facilities,
particularly in urban slums and rural areas, and
to the provision of free health care through the
National Health Service (SNS). Expenditures on
construction of health facilities increased. sub-
stantially in real terms during 1965-67 but con-
tinued to account for only about 2 percent of
public investment expenditure, as under the
Alessandri administration. Between 1964 and mid-
1967, 33 new hospitals and 62 polyclinics and
health centers were completed. The SNS receives
more than 40 percent of the central government's
current transfers to the public sector, or about
10 percent of total current expenditures by the
central government. Nevertheless, the SNS is
encountering increasing financial difficulties,
and the quality of its health services continues
to suffer from deficiencies in facilities, sup-
plies, and manpower. Real improvement probably
can come only with a basic reform of the social
security system, contributions from which currently
cover less than 5 percent of the SNS budget.
28. Frei's efforts to revamp Chile's chaotic
social security system have been unsuccessful so
far. The system consists of 44 insurance funds
(aajas), all operating as independent, quasi-
government agencies under more than 400 laws.
Social security tax rates on payrolls -- paid by
both employers and employees -- are very high (47
percent or more of wages), but revenues still are
inadequate -- in part because the taxes are evaded.
The results have been very wide disparities in
pensions, family allowances, and the many other
benefits offered and an increasing drain on public
resources. President Frei empowered a committee
to draw up recommendations in 1,966 anc: submitted
a reform bill to Congre.as in September 1968,
opposition to which was immediate and loud. The
most likely outcome, as the presidential election
approaches, is a further addition of benefits to
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an already overburdened system that may well col-
lapse before it is renovated.
Balance of Payments
29. The Frei program has benefited from a
dramatic improvement in Chile's balance of payments
since 1964. The fortuitous rise in world copper
prices combined with an increasingly high level of
external aid permitted the replenishing of foreign
exchange reserves, repayment of a large amount of
short-term commercial arrears, and -- perhaps most
important -- the relaxation of the severe restric-
tions on imports that had restrained growth and
added to inflationary pressures throughout the
early 1960's. Chile's terms of trade improved by
a remarkable 56 percent between 1964 and 1966 --
largely because of a rise of almost 50 percent in
copper prices and some reduction in import prices.
At the same time, gross receipts of foreign aid,
mainly from the United States and international
financial organizations, averaged about $240 mil-
lion a year during 1965-66.
30. The growth in export earnings averaged 21
percent annually in 1965 and 1966, almost entirely
because of the rise in copper prices. The value
of copper exports in 1956 was almost $250 million
higher than in 1964 and represented nearly 75 per-
cent of total export earnings compared with about
65 percent in 1964. The Alessandri and Frei govern-
ments used severe exchange and trade restrictions
to hold imports at or below their 1961 level through
1965. In 1966, improvement in the balance of pay-
ments permitted a relaxt;.irn, and imports rose by
25 percent. Although capital equipment and raw
materials accounted for the major portion of the
increase, imports of foodstuffs and durable consumer
goods rose by 19 and 16 percent, respectively.
Imports were not permitted to absorb all of the
increase in export earnings, however. In 1966, as
in 1965, Chile achieved trade surpluses in contrast
to the chronic deficits of the early 1960's (see
the chart).
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1963 196* 1965
*Provisional
31. By devaluating the escudo at a faster rate
than the rise in the consumer price index, the
Frei administration has tried to improve the com-
petitive position of export items other than copper.
Production costs in these industries probably have
risen considerably faster than the rate of devalua-
tion, however, and the crisis of confidence
affecting private investment as a whole has de-
terred expinsion in some export industries as well.
As a result, exports other than copper increased
only from $199 million in 1964 (one-third of total
exports) to $221 million ii' 1968 (one-fourth of
total exports).
32. Because little progress was made in diver-
sifying exports, the expansion in the total export
earnings halted in 1967, when earnings from copper
exports leveled off. At the same time, the deficit
on current account widened as a result of a larger
net outflow for services which consist mainly of
interest payments and profit remittances (see
Table 2). Despite the rise in direct investments
deriving mainly from the copper expansion program,
76080 4-6l CIA
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Chile:
Balance of Payments
Million US $
1967
i958
1960
1961
1962
1963
1964
1965
1966
Provi-
sional
Provi-
sional
Balance on current account
-160
-264
-202
-199
-132
--55
-71
-119
-212
Trade balance
-97
-173
-112
-89
-32
52
83
81
-16
Services and transfers
-63
-91
-90
-110
-100
-108
-154
-200
-196
Interest payments
-23
-32
-39
-43
-40
-66
-74
-73
-85
Profit remittances
-53
-45
-51
-47
-63
-60
-111
-13u
-120
Other services
-14
-33
-13
-23
-5
8
18
1
-7
Transfers
27
19
13
5
8
10
13
lC
16
Balance on capital account
50
137
168
139
160
120
165
130
345
Direct investment (net)
45
49
33
-26
8
-4
19
52
166
Drawings on foreign loans
54
171
208
227
241
217
259
210
314
Official credits
14
98
135
185
198
173
203
160
274
Private sector supplier credi
ts 40
73
73
42
43
44
56
50
40
Amortization of foreign loans
-49
-83
-73
-62
-89
-93
-113
-132
-135
Official credits
-32
-50
-38
-7-19
-56
-49
N.A.
i~.A.
-77
Private sector supplier credi
ts -17
-33
-35
-33
-33
-44
N.A.
N.L.
-58
Errors c~' ~~*i3a'~na
6E
-a
-40
30
-4
-4
28
-6
Change :r ne- foreign reser,,,es
(-
= inc:-ese a, 42
135
74
27
-24
-60
-122
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the net inflow on capital ac-.Hunt dropped in 1967
because of Frei's d?.cision to forgo US budgetary
support in an attempt to induce more responsible
fiscal measures by the Chilean Congress. Chile
consequently suffered a small loss in foreign
exchange reserves.
33. In 1968 the net outflow for services de-
creased somewhat (mainly because rising production
costs and the obligatory "prepayment" of Chilean
taxes cut into net profits remitted by US copper
companies), but Chile's trade account slipped into
deficit for the first time since 1964. Although
world copper prices unexpectedly rose above the
already high level of 1967, labor strikes during
the first half of the year and drought-induced
production difficulties at the end of the year re-
stricted the volume of exports. The total value
of exports in 1968 thus increased by less than 5
percent while imports rose by almost 18 percent.
As a result, the current account deficit grew by
about $100 million in 1968. The continued expansion
of direct investments and a record inflow of for-
eign assistance, however, were more than sufficient
to offset the imbalance. Direct investments by the
US copper companies totaled $135 million. Drawings
on foreign loans, mainly from the US government and
international financial organizations, reached an
all-time high of $314 million. As a result, Chile's
net foreign reserves improved by an estimated $127
million during 1968.
34. Chile has been one of the leading recipients
in the world of US economic aid. During the first
four years of the Frei administration, this aid
totaled some $650 million. In Latin America, Chile
holds first place in the amount of assistance re-
ceived per capita and is second only to Brazil in
the total amount received. US support presumably
was instrumental in Chile's acquisition of more
than $200 million in additional economic assistance
from international financial organizations during
1955-67.
35. Although Chile's foreign debt increased
by nearly $1 billion during 1965-68, the burden of
debt servicing did not increase proportionately.
One of the major campaign issues in 1964 was ?che
heavy load of foreign debt that Chile had built up
through extensive use of suppliers' credits during
the late 1950's and early 1960's. Shortly after
its inauguration, the Frei administration success-
fully sought a rescheduling of debt servicing
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obligations falling due in 1965 and 1966 and agreed
to strict limits on the use of short- and medium-
term suppliers' crelits. The structure of Chile's
foreign debt has been further improved by the more
favorable terms available for US aid since the
initiation of the Alliance for Progress. Chile
has been one of the principal recipients of "soft"
loans under this program.
36. By the end of 1968, Chile's total foreign
debt amounted to an estimated $2.6 billion, or more
than three times the average annual export eaLai.ngs
dui:ing 1965-68. Almost all of the increase in debt
during this period represented liabilities of the
public sector, as shown in the following tabula-
tion:
Billion US $
1964
1965
1966
'967
1968
Public debt and
government-
guaranteed
private debt
1,2
1.3
1.6
1.9
2.1
Other known
private debt
0.5
0.5
0.4
0.5
0.5
Total foreign
debt
1.7
1.8
2.0
2.4
2.6
The ratio of servicing obligations* to total export
receipts varied between 22 and 24 percent during
1965-68. This ratio may increase to as much as 30
percent in 1969, however -- mainly because amortiza-
tion payments on public foreign debt are scheduled
to increase. Although debt repayments are expected
to continue at a high level over the next several
years, the servicing ratio may be lower after
1970-71, when completion of the copper expansion
program will permit an increased volume of copper
exports. Nevertheless, as a condition for the ex-
tension of a standby loan for 1969-70, the IMF has
required ceilings on additions to Chile's foreign
debt that must be repaid in less than 15 years.
Amortization and interest on public foreign debt
(excluding liabilities of the Central Bank),
government-guaranteed private debt, and known pri-
vate debt.
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Pace of Inflation
37. Failure to slow the pace of inflation is
one of the most important economic shortcomings of
the Frei administration and a highly damaging
matter politically. Ths basic cause of the failure
is the collapse of the government's wage policy in
the face of intense opposition from the left, in-
cluding some factions of the PDC. This opposition
has made a shambles of the stabilization policy that
Frei announced shortly after his inauguration.
38. The new stabilization policy was designed
to end inflation over a period of four years, re-
ducing the rate gradually so that increased unem-
ployment and economic recession might be avoided.
In order to gain the public's confidence that a
consistent "war on inflation" would be waged, the
government widely publicized its commitment to spe-
cific goals. The program called for reduction of
increases (end-of-year basis) in the consumer price
index from 38 percent in 1964 to 25 percent in
1965, 15 percent in 1966, and 10 percent in 1967
and for relative price stability from 1968 on.
Wages were to be adjusted annually in line with the
rise in the cost of living during the preceding
year, which under conditions of decelerating infla-
tion would permit increases in real wages. At the
same time, the government intended to foster changes
in relative prices to correct distortions.
39. Frei's program was an appropriate, encour-
aging response to the economic problems that Chile
then faced. Moreover, the dramatic improvement in
the balance of payments and the sharp increase in
government revenues during the first years of the
Frei administration were strongly favorable to the
use of fiscal and monetary policies to achieve both
pricy stability and economic growth. The adminis-
tration did manage to take some steps designed to
reduce both inflation and its detrimental effect on
the allocation of resources: it strengthened the
tax system, liberalized import controls, adopted
more flexible exchange rates, and provided for
adjustments in savings accounts to reflect the
increase in prices.
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40. These gains were overshadowed, however, by
the administration's inability to hold down wage
increases. A large part of the blame must be
attributed to Frei's failure to exercise strong
leadership early in his term, when his influence
in the Congress was at its height and the range of
palatable options at its broadest. The Congress
sabotaged the stabilization effort mainly by passing
bills allowing wage increases far in excess of the
administration's guidelines. As a consequence,
real wages in the public sector expanded by some 42
percent during 1965-67. The large increases given
to public employees made it impossible to balance
the budget. They also made it increasingly diffi-
cult for the private sector to observe the adminis-
tration guidelines, and real wages in private employ-
ment rose at even a faster rate.
41. The government's financial problems led to
neglect of productive investment and required bor-
rowing from the banks, which restricted credit
available to private business. Large wage gains
and tax increases boosted costs in the private
sector, stepping up inflationary pressures and
putting a cost-price squeeze on some firms that
discouraged investment and contributed to the slow-
down in economic growth. Through its ta::, price,
and wage policies, the administration encouraged a
redistribution of national income toward wage
earners that has fundamentally altered the attrac-
tiveness of business enterprise in Chile.
42. Despite worsening inflationary pressures
from accelerated government spending, rapidly rising
real wages, and a large expansion in the money sup-
ply (65 percent in 1965 and 39 percent in 1966),
the government managed to adhere fairly closely to
its price targets during the first two years of the
stabilization program. Prices rose by 26 percent
in 1965 and 17 percent in 1966. This achievement,
however, was largely the result of price controls
and emergency measures. In September 1966, when
the cost-of-living index already had risen 21 per-
cent above the level of December 1965, the govern-
ment fell back on extraordinary food imports,
direct control of the wholesale vegetable market,
and other emergency measures to drive the index
down closer to the planned level. In 1967 the
combination of pent-up demand, rising real costs,
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and stagnating output was too strong for price
controls to be effective, and the cost of living
rose by 22 percent. Excessive monetary expansion
during 1968 resulted from the government's
worsening financial position and added signifi-
cantly to the upward pressure on prices (see the
chart). By August the cost of living had risen
26 percent, and the increase for 1968 as a whole
Cost of Living
100
1964 1965 1966
was held to 28 percent
only through emergency
efforts to depress food
prices during the last
quarter. In January and
February 1969 the cost-of-
living index rose by
almost 11 percent.
Economic Prospects
for 1969-70
43. Chile's economic
prospects for 1969-70 are
distinctly unfavorable.
At the end of four years
in office, the Frei admin-
istration is caught in the
quandary of economic stag-
nation and inflation --
to which there are no
happy solutions. In addi-
tion, the government faces
serious problems as a result of the severe drought
and the expected stagnation or decline in copper
prices. As the presidential elections approach,
moreover, pressures for government spending on wages
and welfare almost certainly will intensify, further
straining budget resources and accelerating infla-
tion. Business confidence probably will reach a new
low, thus further slowing the growth of investment
and output. The trade deficit is expected to reach
a record level in 1969 and remain large in 1970. One
bright spot in the picture is the likaly expansion of
foreign assistance, at least in 1969. Another impor-
tant favorable factor is the $530 million copper
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expansion program, four-fifths of which is being
financed by the US copper companies (whose in-
vestments are insured under the US investment
guaranty program). But it is possible that these
companies will be expropriated even before the
scheduled completion of the expansion program in
1971.
44. In part, the economic outlook is bleak
because the chances for positive government action
seem slim. Frei will be a lame duck during 1969-70
and will have even greater difficulty than in the
past in forging majorities for measures of economic
readjustment. Considering what the administration
accomplished when luck was on its side, it is dif-
ficult to expect much from it as major problems
build up in the midst of an election campaign.
Even without the drought problem, per capita output
probably would not have grown in 1969, and the
inflationary spiral would have been politically
difficult to curb. If the drought eases during 1969,
GNP should recover partially in 1970, but the pop-
ulation will still have much cause for dissatisfac-
tion with the economy. To minimize the extent of
recession and unemployment, the administration dur-
ing the next two years will be strongly tempted to
employ expansionary fiscal and monetary policies --
as it has in the past under far less trying circum-
stances. This approach could increase the rate of
inflation to as much as 40 or 50 percent annually,
which would be both economically irresponsible and
politically risky. The administration may, however,
decide to gamble on the preservation of a false
sense of prosperity rather than to "tell it like it
is" to people on their way to the polls.
45. Chile's drought -- the worst in 44 years --
is badly disrupting output in the most important
agricultural region. Total agricultural output
probably will drop by 20 to 30 percent in 1969.
Through its impact on agricultural output, the
agricultural processing industries, hydroelectric
power supplies, and large industrial users of power,
the drought could cause a decline of 5 to 10 percent
in GDP per capita. This misfortune also will aggra-
vate budget and balance-of-payments problems,
increase unemployment in both rural and urban areas,
strengthen inflationary pressures, and heighten
popular unrest. Electric power output should
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largely recover in 1970, if precipitation is :nor-
mal in mid-1969. But agricultural production will
continue to suffer from inadequate soil moisture,
damaged orchards and vineyards, and depleted live-
stock herds.*
46. The prospective stagnation or decline in
the world price for copper may bring a decline in
export earnings in 1969-70 from the unusually high
levels of 1965-68. Under the best of circumstances,
it is unlikely that export earnings will be an
important factor in the growth of national income,
as they were during the early years of the Frei
administration. Inasmuch as the drought is reducing
supplies of hydroelectric power and water (which is
needed for ore concentration), production and ex-
ports of copper in 1969 probably will be lower than
had been projected. The scheduled expansion of the
industry may allow export earnings in 1970 to be
restored only to the level of 1967-68. Lxport
capacity is being developed in such industries as
steel, cellulose, paper, and petrochemicals. How-
ever, because of the time needed for completion of
these projects, there probably will not be any
significant diversification of the export structure
during 1969-70.
47. The combined impact of reduced export earn-
ings and expanded imports could raise Chile's trade
deficit to a record high of about $250 million in
1969. Assuming a further reduction in profit remit-
tances by US copper companies, the net outflow for
services should decline somewhat. Nevertheless,
Chile's deficit on current account in 1969 may
amount to about $430 million -- or about one-half
of total export earnings. US aid to Chile is
expected to increase in 1969, despite the large US
Congressional cut in total aid to Latin America.
At the end of 1968, AID estimated that drawings on
foreign loans and direct foreign investment
(mainly by the US copper companies) would approxi-
mate $600 million in 1969. Such an inflow of
capital would be sufficient to cover the prospec-
tive deficit on current account and finance sched-
uled debt repayments (see Table 3).
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Projected Changan in Balance os Payments
from 1968 to 196y
Balance on ourront. acsccunt
Trade balance
Lxports (f.o.b.)
'mports (c.i.f.)
Services and transfers
Interest payments
Profit remittances
Other services
Transfers
Million US $
1968
Provi- 1969
sional Projected
-212 -430
-16 -252
910 856
-926 -1,108
-196 -178
-85 -83
-120 -106
-7 -5
16 16
Balance on capital account 345 432
Direct investment (net) 166 190
Copper expansion program 135 169
Other investment (net) 31 21
Drawings on foreign loans 314 417
Official credits 274 382
Private sector supplier
credits 40 35
Amortization of foreign loans -135 -175
Official credits -77 -118
Private sector supplier
credits -58 -57
Errors and omissions
Change in net foreign reserves
(- = increase) -127 -2
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SIAC R E'I,
48. In 1970, however, the Frei administration
may find it more difficult to avoid serious
balance-of-payments problems and a return to
stricter import and exchange controls, despite
their negative effect on both price stability and
economic growth. If normal weather returns and
the copper expansion program proceeds an scheduled,
Chile probably will be able to reduce its trade
deficit in 1970, though not necessarily to the
level of 1968. The net outflow of funds for serv-
ices and amortization payments on foreign debt is
expected to increase. Although Chile's gross
foreign exchange reserves reportedly increased to
somewhat more than $200 million at the end of 1968,
foreign capital will continue to be needed to cover
these outflows. Chile probably will continue to
have a high priority for US aid, but the US govern-
ment may not be able to respond fully to Chilean
financial needs in 1970 if the US Congress does
not raise the overall ceilings on aid to Latin
America. Moreover, increased pro-election clamor
for new agreements with the US copper companies
or for nationalization of the properties could
have an adverse effect on the level of US aid and
possibly slow the inflow of direct investments.
49. Prospects for fiscal and monetary stability
also are unfavorable. In an attempt to avoid the
wage readjustment debacle of 1968, the Frei admin-
istration included its wage readjustment legislation
in the 1969 budget bill. As submitted, the legis-
lation provided for a general increase of only 22
percent in public sector wages, but special raises
authorized (but not fully paid) last year will bring
the overall rise in the public sector wage bill to
38 percent. The budget assumes the receipt of food
imports under PL 480 that total $40 million. The
proceeds in escudos from the sale of these importer
are to be used for drought relief and are the only
amount provided for this purpose in the budget. No
provision is made for the additional $43 million in
debt servicing payments required for 1969 or for
about $40 million in new investments originally
planned for next year. On this basis, the budget
contains a deficit of $48 million, which the
administration proposes to finance through reimposi-
tion of the wealth tax and continuation of the
forced loans from the US copper companies and other
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SE(; R F' I'
corporations. Implementation of adminf st,tation
plans for additional expenditures not Included in
the budget submitted to the Congronn would increase
substantially the size of the deficit. The admin-
istration in counting on enlarged program loans and
other budget support from the U?3 government an a
major source of financing,
50. In view of its past performance and the up-
coming elections, the Con4ress can be expected to
attempt to expand the budgeted level of current
expenditures, particularly for wages. Chilean
politicians, including r mbers of the PUC, already
are studying means of financing an additional wage
increase in 1969. It will be politically difficult
for the administration to defend the need for a
general wage increase below the level of last year's
rise in the cost of living. Public investment ex-
penditures probably can be cut little without a
negative impact on politically important welfare
projects and on employment levels. If Chile does
not hold budget expenditures and mu'ietary expansion
within certain limits, however, continued receipt of
budget support aid from the United States and
drawings on standby credits from the IMF could be
endangered. The added inflationary pressures that
would result from domestic financing of a budget
deficit substantially larger than that originally
planned also present very serious political risks.
Pressures for wage raises in the private sector,
which will be very difficult to withstand, are likely
to result in a further increase in the pace of infla-
tion. In sum, it appears that the administration
will have to choose among several unpalatable
alternatives -- any one of which will tend to cancel
out the political advantages gained from its ability
to pursue permissive policies in the past.
51. As Chile's financial problems mount, both
the government and its opposition will be increas-
ingly tempted to seek politically popular solutions,
even though they may be economically short-sighted.
The most tempting solution probably would be a grab
for a larger share or all of the profits of the US
copper companies or a default on foreign debt
servicing payments. Even outright expropriation of
the US copper companies probably would not benefit
Chile's budget or balance of payments for very long,
however. If arrangements for adequate compensation
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81`GRIT
were made, the payments probably would largely
offset the government's added revenues from the
companion' profits (which are likely to decline
under Chilean management). If adequate compensa-
tion were not offered, Chile would stand to lose
more in US economic aid and inflows of private
capital than it gained from sequestering the
companies' total profits. In the somewhat less
likely event that payments were withheld on the
foreign R1ebt -- about half of which in owed to the
US government -- Chile's credit standing through-
out the world would be damaged.
52. The US government's financial liability if
the copper companies are expropriated could be
sizable by 1970. Copper investments of between
$425 million and $450 million that were made before
the current expansion program are not insured under
the Specific Risk Investment Guaranty Act. But the
US government may have a liability of as much as
$400 million by the and of 1970, if the expansion
program proceeds as scheduled. These insured
investments probably will be carried out, since
the US companies have nothing to lose by doing so.
The Chilean Congress might try to nationalize the
copper properties before Frei's term ends, in
November 1970. It seems unlikely, however, that
Frei would approve a congressional expropriation
measure, though he might try to secure a much larger
share of the companies' profits for Chile. A con-
frontation between Frei and the Congress on this
issue could bring a political crisis, with unpre-
dictable consequences.
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