Chile - Economic Crisis and the Military Coup

Economic crisis and the military coup

After assuming power in November 1970, the UP rapidly began to implement its program. In the area of structural reforms, two basic measures were immediately begun. First, agrarian reform was greatly intensified, and a large number of farms was expropriated. Second, the government proposed to change the constitution in order to nationalize the large copper mines, which were jointly owned by large United States firms and the Chilean state.

Government expenditures expanded greatly, and in 1971 real salaries and wages in the public sector increased 48 percent, on average. Salaries in the private sector grew at approximately the same rate. In the first two quarters of 1971, manufacturing output increased 6.2 percent and 10.6 percent compared with the same periods in the previous year. Manufacturing sales grew at even faster rates: 12 percent during the first quarter and 11 percent during the second quarter. Overall, the behavior of the economy in 1971 seemed to vindicate the UP economists: real GDP grew at 7.7 percent, average real wages increased by 17 percent, aggregate consumption grew at a real rate of 13.2 percent, and the rate of unemployment dipped below 4 percent. Also, and more important for the UP political leaders, income distribution improved significantly. In 1971 labor's share of GDP reached 61.7 percent, almost ten percentage points higher than in 1970. All of this created a sense of euphoria in the government.

On June 11, 1971, Congress approved unanimously an amendment to the constitution nationalizing large copper mines. As a result, reform of the banking system and large manufacturing firms was more difficult because the government lacked the institutional means to implement nationalization. Initially, this obstacle was alleviated because the government purchased blocks of shares, especially bank shares, at high prices. These share acquisitions were complemented by a process of requisition or expropriation of foreign-owned companies based on an old, and until then forgotten, decree law promulgated during Marmaduke Grove Vallejo's short-lived Socialist Republic of 1932.

All did not remain well in the economy in 1971. The UP's macroeconomic policies were rapidly generating a situation of repressed inflation. The high growth rate of GDP was largely the result of an almost 40 percent increase in imports of intermediate goods. The fiscal deficit had jumped from 2 percent of GDP in 1970 to almost 11 percent in 1971. The rate at which the money supply grew exceeded 100 percent in 1971. As a result, the stock of international reserves inherited by the Allende government was reduced by more than one-half in that year alone. A rapid reduction of inventories was another important factor in the expansion of consumption.

By the end of 1971, the mounting inflationary pressures had become evident. The economy was experiencing the consequences of an aggregate demand for goods and services well above the aggregate supply at current prices. This imbalance was aggravated by a series of labor disputes in many large establishments that resulted in the takeover of those firms by their workers. In fact, this procedure became the institutionalized way in which the government seized a large number of firms.

During 1972 the macroeconomic problems continued to mount. Inflation surpassed 200 percent, and the fiscal deficit surpassed 13 percent of GDP. Domestic credit to the public sector grew at almost 300 percent, and international reserves dipped below US$77 million.

The underground economy grew as more and more activities moved out of the official economy. As a result, more and more sources of tax revenues disappeared. A vicious cycle began: repressed inflation encouraged the informal economy, thus reducing tax revenues and leading to higher deficits and even higher inflation. In 1972 two stabilization programs were implemented, both unsuccessfully.

When evaluating the problems faced by the economy, UP economists generally held the view that the authorities had failed to impose appropriate controls in implementing Allende's program. This view guided the first, rather weak, attempt at stabilizing the economy that was launched in February 1972. Price controls were the main ingredient of the program. By mid-1972 it was apparent that the February stabilization program was a failure. The underground economy was now widespread, output had begun to fall, open inflation reached an annual rate of 70 percent in the second quarter, foreign-exchange reserves were very low, and the blackmarket value of the currency was falling rapidly. Parliamentary elections scheduled for March 1973 made the situation particularly difficult for the UP. In August 1972, a new stabilization program was launched under the political monitoring of the PCCh. This time, not only prices were officially controlled, but the distribution channels were taken over by the government, in an attempt to reduce the extent of the black market.

Unlike the previous plan, the August 1972 stabilization program was based on a massive devaluation of the escudo. The government expected that the result would be an easing of the mounting pressures on the balance of payments. The program also called for two basic measures to contain fiscal pressures. First, nationalized firms were authorized to increase prices as a means of reducing the financing requirements of the newly formed nationalized sector. Second, the program called for a massive increase in production, especially in the recently nationalized manufacturing and agriculture sectors (large manufacturing firms and farms had been expropriated arbitrarily). The devaluation and a large number of price increases resulted in annualized inflation rates of 22.7 percent in August and 22.2 percent in September.

In mid-August 1972, the government announced that it had drafted a new wage policy based on an increase in publicand private-sector wages by a proportion equal to the accumulated rate of inflation between January and September. In addition, the new policy called for more frequent wage adjustments.

During the first quarter of 1973, Chile's economic problems became extremely serious. Inflation reached an annual rate of more than 120 percent, industrial output declined by almost 6 percent, and foreign-exchange reserves held by the Central Bank were barely above US$40 million. The black market by then covered a widening range of transactions in foreign exchange. The fiscal deficit continued to climb as a result of spiraling expenditures and of rapidly disappearing sources of taxation. For that year, the fiscal deficit ended up exceeding 23 percent of GDP.

The depth of the economic crisis seriously affected the middle class, and relations between the UP government and the political opposition became increasingly confrontational. On September 11, 1973, the UP regime came to a sudden and shocking end with a military coup and President Allende's suicide.

When the military took over, the country was divided politically, and the economy was a shambles. Inflation was galloping, and relative price distortions, stemming mainly from massive price controls, were endemic. In addition, black-market activities were rampant, real wages had dropped drastically, the economic prospects of the middle class had darkened, the external sector was facing a serious crisis, production and investment were falling steeply, and government finances were completely out of hand.

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