Evolution of the Economy
In colonial times, the segmentation of Chile into latifundios left only small parcels for native American and mestizo villagers to cultivate. Cattle raised on the latifundios were a source of tallow and hides, which were sent, via Peru, to Spain. Wheat was Chile's principal export during the colonial period. From the inquilinos (peons), indentured to the encomenderos, or latifundio owners, to the merchants and encomenderos themselves, a chain of dependent relations ran all the way to the Spanish metropolis.
After Chile won its independence in 1818, the economy prospered through a combination of mercantilist and free-market policies. Agricultural exports, primarily wheat, were the mainstay of the export economy. By mid-century, however, Chile had become one of the world's leading producers of copper. After Chile defeated Bolivia and Peru in the War of the Pacific (1879-83), nitrate mines in areas conquered during the war became the source of huge revenues, which were lavished on imports, public works projects, education, and, less directly, the expansion of an incipient industrial sector. Between 1890 and 1924, nitrate output averaged about a quarter of GDP. Taxes on nitrate exports accounted for about half of the government's ordinary budget revenues from 1880 to 1920. By 1910 Chile had established itself as one of the most prosperous countries in Latin America.
Dependence on revenues from nitrate exports contributed to financial instability because the size of government expenditures depended on the vagaries of the export market. Indeed, Chile was faced with a severe domestic crisis when the nitrate bonanza ended abruptly during World War I as a result of the invention of synthetic substitutes by German scientists. Gradually, copper replaced nitrates as Chile's main export commodity. Using new technologies that made it feasible to extract copper from lowergrade ores, United States companies bought existing Chilean mines for large-scale development.
Chile initially felt the impact of the Great Depression in 1930, when GDP dropped 14 percent, mining income declined 27 percent, and export earnings fell 28 percent. By 1932 GDP had shrunk to less than half of what it had been in 1929, exacting a terrible toll in unemployment and business failures. The League of Nations labeled Chile the country hardest hit by the Great Depression because 80 percent of government revenue came from exports of copper and nitrates, which were in low demand.
Influenced profoundly by the Great Depression, many national leaders promoted the development of local industry in an effort to insulate the economy from future external shocks. After six years of government austerity measures, which succeeded in reestablishing Chile's creditworthiness, Chileans elected to office during the 1938-58 period a succession of center and left-of-center governments interested in promoting economic growth by means of government intervention.
Prompted in part by the devastating earthquake of 1939, the Chilean government created the Production Development Corporation (Corporación de Fomento de la Producción--Corfo) to encourage with subsidies and direct investments an ambitious program of importsubstitution industrialization. Consequently, as in other Latin American countries, protectionism became an entrenched aspect of the Chilean economy.
Import-substitution industrialization was spurred on by the advent of World War II and the loss of access to many imported products. State enterprises in electric power, steel, petroleum, and other heavy industries were also created and expanded during the first years of the industrialization process, mostly under the guidance of Corfo, and the foundations of the manufacturing sector were set. Between 1937 and 1950, the manufacturing sector grew at an average yearly real rate of almost 7 percent.
Despite initially impressive rates of growth, importsubstitution industrialization did not produce a sustainable expansion of the manufacturing sector. With the industrialization process evolved an array of restrictions, controls, and often contradictory regulations. With time, consumer-oriented industries found that their markets were limited in a society where a large percentage of the population was poor and where many rural inhabitants lived at the margins of the money economy. The economic model did not generate a viable capital goods industry because firms relied on imports of often outmoded capital and intermediate goods. Survival often depended on state subsidies or state protection. In fact, it was because of these import restrictions that many of the domestic industries were able to survive. For example, a number of comparative studies have indicated that Chile had one of the highest, and more variable, structures of protection in the developing world. As a consequence, many, if not most, of the industries created under the importsubstitution industrialization strategy were inefficient. Also, it has been argued that this strategy led to the use of highly capital-intensive production, which, among other inefficiencies, hampered job creation. Additionally, the importsubstitution industrialization strategy generated an economy that was particularly vulnerable to external shocks.
During the import-substitution industrialization period, copper continued to be the principal export commodity and source of foreign exchange, as well as an important generator of government revenues. The Chilean government's retained share of the value of copper output increased from about one-quarter in 1925 to over four-fifths in 1970, mainly through higher taxes. Although protectionist policies better insulated Chile from the occasional shocks of world commodities markets, price shifts continued to take their toll.
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