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Thursday, April 28, 2016

Chile An Island Of Stability In South America

Chile: An Island of Stability in South America

    
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Forecast

  • Despite the shock from falling copper prices, Chile's responsible management of public finances will ensure a measure of domestic economic stability in years to come.
  • The repeal of Chile's binomial electoral system could lead to more small parties reaching the National Congress in the next election cycle but will not destabilize Chilean politics.
  • It is unlikely that Chile's governments in the near future will look to drastically increase public spending or repeal the legislation that commits the nation to limiting public spending.

Analysis

Latin America's economies have reacted differently to the drop in global commodity prices over the past several years. With Chinese demand growth slowing and economic growth relatively slow in Europe and the United States, Latin America's commodity boom is essentially over. In Brazil, the decline in prices for key exports such as soybeans and iron ore exposed severe structural economic problems. In Venezuela, the drop in oil prices since 2014 plunged the country into a social crisisthreatening the government's hold over the nation. But Chile is a different story.
The Chilean economy is particularly vulnerable to shocks caused by drops in copper prices abroad. After all, 49 percent of the country's exports are related to the copper industry, and mining activities account for about 14 percent of Chile's gross domestic product. But Chile has weathered the drop in copper prices — which have plunged by 35 percent since their peak in 2011 — thanks to government policies enacted in the recent past. 
Chile's geography makes it inherently vulnerable to the boom-and-bust cycle that has characterized so many Latin American economies. On a continent where dense forests, rivers and mountains isolate many countries from one another like islands, Chile has historically been a peripheral nation. It has no choice but to rely on markets outside the continent for much of its export revenue. Some of the highest peaks in the Andes separate Chile from the consumer markets of Argentina. Even Peru and Bolivia, nations relatively more accessible to Chilean exporters, are hundreds of kilometers from Chile's population centers and economic core in its central region.
And none of those nations represent significant consumer markets for Chilean manufactured goods, nor do they possess the manufacturing activity to use Chile's copper. Consequently, the Chilean strategy for development has been to rely on export markets in Europe, the United States and, most recently, East Asia. Exports to East Asia and the United States in 2015 accounted for about 55 percent of Chilean export revenue, whereas neighboring Peru accounted for only about 2.5 percent of exports.

Economic Stability and Political Reform

Despite Chile's vulnerability to boom-and-bust cycles, a key factor in its recent stability is its commitment to fiscal responsibility. The Chilean government's resistance to potentially destabilizing moves — particularly those prioritizing major increases in public spending — is enforced by Chilean law. This has not always been the case. As in other Latin American countries, Chile's governments in the 1960s encouraged fiscal deficits, and the efforts to finance those deficits led to high inflation. Chile's economic stability was secured by a fiscal rule instituted in 2000, and later enshrined in law, mandating that the government must attempt each year to secure a structural surplus equal to 1 percent of the gross domestic product.
That requirement significantly curtails the government's capacity to boost populist spending because it must save money in an effort to reach the target. The surplus can then be used to bolster the country's public finances during lean times. It is unlikely that future governments will undo the fiscal rule to, for example, boost public spending. Without a majority in Chile's National Congress, any political party would find changing the law a challenge.
Yet Chile's domestic politics could be somewhat different in the next election cycle. Electoral reform in 2015 eliminated Chile's binomial electoral system, which ensured representation for the country's right and left blocs in each electoral district except in cases in which either bloc's representatives won with twice the number of votes received by the opposing candidate. The system effectively ensured more equal representation for the country's right- and left-wing parties and made it difficult for any party to gain a distinct advantage in either congressional house.
The 2015 reform shifted the electoral format toward proportional representation, meaning smaller parties could win seats in the National Congress without having to join one of the two major political blocs. This opens the way for a proliferation of smaller parties, potentially upsetting the balance between the left- and right-wing coalitions that have governed since the end of the Augusto Pinochet government in 1990.

A Run of Good Fortune

Chile is an outlier in Latin America precisely because it is so politically and economically stable. Overall, Chile's experience is a notable example of moderate politicians successfully managing an economic windfall. Not all countries in the region managed the commodity boom successfully, and some are now experiencing the side effects of high spending during the boom times.
There are no visible disruptors in the near term to Chile's three-decade run of good economic fortune. Rising global copper demand could soon boost prices, providing the government some relief. And while the removal of the binomial system may bring more parties into the government, there is no sign that they will create major instability in the political system or attempt to push through reforms that would undo the country's fiscal stability and reduce its attractiveness to foreign investors. Still, the next few years will inevitably be a time of slower economic growth for Chile unless copper demand and prices rise. With copper prices well below the highs of the late 2000s, Chile's economy is projected to grow by only about 3.1 percent in 2016, compared with nearly 6 percent in 2011.