Can't rely on copper to pull it out of its middle-income funk.
The first round of Chile's presidential elections, which saw a near shoo-in billionaire stumble, has roiled the continent's traditional pacesetter. The day after conservative former president Sebastian Pinera garnered less than 37 percent of the vote, the stock market took a powder. Now Pinera faces a December runoff against Alejandro Guillier, a relative political newcomer, who’s bidding to unite the bickering but surprisingly resurgent Chilean left.
Yes, Chileans seem as tired of the same old faces in politics as everyone else in Latin America does. So is the continent's most business-friendly nation about to bank hard left? Nah. Chileans long ago eschewed ideological extremes for a dull but stabilizing centrism. What’s at stake is whether any government can shake off more than a decade of economic inertia.
Chile hasn't lost its preeminence. This Andean sliver of a nation of 18 million still leads in everything from free trade and quality of living to classroom performance. It trumps many of its neighbors for market friendliness, scoring 57 on the World Bank’s ease of doing business index, compared with Argentina (117) and Brazil (125). And thanks to a surge in growth and productivity starting in the 1980s, Chile debuted as the region’s first high-income nation in 2012.
The trouble is, Chile has been idling. The economy hit a rough patch, with growth falling from 1.6 percent in 2016 to a projected 1.1 percent this year, according to data compiled by Bloomberg Intelligence, below the regional average. For the first time in decades, Standard & Poor’s has downgraded Chile’s sovereign debt, citing “prolonged subdued economic growth.” Bloomberg data touts Chile to bounce back strongly in 2018, but thanks largely to sharply rebounding copper prices.Yet like its copper ore -- indeed, perhaps because of it -- Chile’s economic torpor runs deep. That one mineral kicks in half its export revenues, as it has for the past half-century or more. “Chile is still largely dependent on one commodity, copper, and selling it to one country, China,” Alfonso Dingemans, an economic historian at the University of Santiago, told me.
The greater worry is Chile’s underwhelming track record, even in the industries it ought to rule. In mining, for example, productivity has stalled. “With an economy dependent on mining, it should trouble us that productivity in this sector has fallen 1.2 percent annually over the last 15 years,” Jorge Selaive, chief economist at BBVA Research Chile wrote in a recent report. Even accounting for declining mineral quality, productivity in the country’s signature industry is growing at a sluggish 1 to 1.5 percent a year, according to University of Chile economist Jose de Gregorio, a fellow at the Peterson Institute for International Economics. That makes Chile less productive than its mining peers Peru and Australia, according to Selaive.
What’s troubling Chile is a classic ailment: the middle income trap. Roughly put, that’s the speed bump advanced developing economies hit when they’re no longer poor but not yet rich. Chile, Dingemans argued, is too well-off to compete with low-wage countries, and its productivity is too low to compete with richer, high-productivity nations.
Even as it caught stardust as Latin America’s leanest and most efficient economy, Chile has dawdled on innovation. Compared with its wealthier peers in the Organization for Economic Cooperation and Development, last year Chile ranked dead last in spending on research and development, just behind Mexico, investing a paltry 0.38 percent of gross domestic product. It also registered an underwhelming 3,274 patents in 2016, out of more than 62,000 in the region.
To be sure, Chile has launched important initiatives to spur inventiveness and enterprise: Start-Up Chile, an incubator for entrepreneurs, has earned the charming sobriquet Chilecon Valley. By some measures, these initiatives have paid off: more than 1,300 startups from 72 countries, reportedly valued at $1.4 billion.
Yet some early reports suggested the program was struggling. Of 663 startups, by 2013, only around 12.7 percent had secured additional financing from venture capitalists, an important measure for success. “We need to see a lot more information,” said University of the Andes economist Juan Nagel. “How many of these are new jobs? How many patents have these businesses registered? And is Chile’s economy more diversified as a result? Clearly that is not something that is being accomplished; otherwise they would say so.”
While Chile idles, some of the region’s bigger markets, such as Mexico and Argentina, are shedding some of the flawed policies and political dysfunctions holding them back. Consider lithium mining, long tightly controlled by Chile as a strategic national industry. While Chilean miners must obtain special authorization and may face tightening environmental restrictions, Argentine President Mauricio Macri is hailing prospectors to the country’s lithium-rich brine flats by pruning regulations and proposing to revamp a glacier protection law.
Even the sommeliers have taken note. True, Chile’s marquee industry still lords over the region. But international wine critic James Suckling named six Argentine labels on his most recent list of 100 best wines, and celebrated French vintner Michel Rolland even called the produce in Argentina (where he also has a winery) “superior” to Chile’s. “Chile is beginning to feel other countries breathing down its neck,” said Nagel.
The good news is that Chileans are well aware of their middle income trap, and searching for exits. But here is where the vaunted Chilean consensus goes off road. Pinera is talking up a new Office for Competitiveness, financed by tax cuts and deregulation. Chile’s left, meanwhile, calls for corporate taxes to boost spending on science and technology, much as outgoing President Michelle Bachelet has done. “Both campaigns speak of returning to higher growth,” said Dingemans. “There is no talk, however, of a new set of policies. Apparently, those are not needed!”
Lost in the partisan noise is the failure of both the markets-first strategy and state stewardship to diversify the economy or enhance productivity. “Chile’s done well with copper, wine, fruit and forestry, seafood and a bit of manufacturing – the same as it has for the last 25 years,” said Nagel. “But the trouble is making the leap to other industries.”
Instead of doubling down on their orthodoxies, Dingemans argued, Chileans need to get practical. “We have to get beyond the preconceived notions that either the state or the market has to solve our problems,” he said. That’s a sentiment that even Chile’s wine snobs ought to be willing to toast.
By Marc Margolis