The Popular Unity Government, 1970-73

The Popular Unity Government, 1970-73

In September 1970, Salvador Allende, the UP candidate, was elected president of Chile. Over the next three years, a unique political and economic experience followed. The UP was a coalition of left and center-left parties dominated by the Socialist Party (Partido Socialista--PS) and the Communist Party of Chile (Partido Comunista de Chile--PCCh), both of which sought to implement deep institutional, political, and economic reforms. The UP's program called for a democratic "Chilean road to socialism".

When Allende took office in November 1970, his UP government faced a stagnant economy weakened by inflation, which hit a rate of 35 percent in 1970. Between 1967 and 1970, real GDP per capita had grown only 1.2 percent per annum, a rate significantly below the Latin American average. The balance of payments had shown substantial surpluses during all but one of the years from 1964 to 1970, and, at the time the UP took power, the Central Bank of Chile had a stock of international reserves of approximately US$400 million.

The UP had a number of short-run economic objectives: initiating structural economic transformations, including a program of nationalization; increasing real wages; reducing inflation; spurring economic growth; increasing consumption, especially by poorer people; and reducing the economy's dependence on the rest of the world. The UP's nationalization program was to be achieved by a combination of new legislation, requisitions, and stock purchases from small shareholders. The other goals--output and increased consumption, with rising salaries and declining inflation--were to be accomplished by a boost in aggregate demand, mainly generated by higher government expenditures, accompanied by strict price controls and measures to redistribute income.

The UP's macroeconomic program was based on several key assumptions, the most important being that the manufacturing sector had ample underutilized capacity. This provided the theoretical basis for the belief that large fiscal deficits would not necessarily be inflationary. The lack of full utilization was, in turn, attributed to two fundamental factors: the monopolistic nature of the manufacturing industry and the structure of income distribution. Based on this diagnosis, it was thought that if income were redistributed toward the poorer groups through wage increases and if prices were properly controlled, there would be a significant expansion of demand and output.

In regard to inflation, the UP program placed blame on structural rigidities (namely, slow or no response of quantity supplied to price increases), bottlenecks, and the role of monopolistic pricing, and it played down the role of fiscal pressures and money creation. Little attention was paid to the financial sector, given the orientation of the new regime's economic technocrats toward the import-substitution, structuralist philosophy of the Economic Commission for Latin America. In fact, Allende's minister of foreign relations and vice president, Clodomiro Almeyda, relates in his memoirs how in the first postelection meeting of the economic team, these technocrats argued expressly and convincingly that monetary and financial management did not deserve too much attention. Alfonso Inostroza, the Central Bank president, stated in early 1971 that the main objective of the monetary policy was to "transform it into a key instrument . . . to achieve the complete mobilization of productive resources, and their allocation to those areas that the government gives priority to . . . ." This was consistent with the view of inflation of those espousing structuralism.

The UP perspective on the way the economy functioned ignored many of the key principles of traditional economic theory. This was reflected in the greatly diminished attention given to monetary policies, but also in the complete disregard of the exchange rate as a key variable in determining macroeconomic equilibrium. In particular, the UP program and policies paid no attention to the role of the real exchange rate as a determinant of the country's international competitive position. Moreover, the UP failed to recognize that its policies would not be sustainable in the medium term and that capacity constraints were going to become an insurmountable obstacle to rapid growth.

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