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Chile’s interesting example

April 26th, 2009 · No Comments

As we’ve argued elsewhere, the quality of government matters much more than it’s ‘quantity.’ Chile is a definite example of this, and provides some interesting lessons, lessons from evidence based policies that we favour over ideologically informed (let alone self-serving) ones..

Harvard Peso Doctor Vindicated as Chile Evades Slump

By Sebastian Boyd

April 23 (Bloomberg) — Thousands of government workers marched on downtown Santiago last November, burning an effigy of Chilean Finance Minister Andres Velasco and calling him “disgusting” as a strike for higher wages paralyzed public services.

Five months later, polls show that Velasco is President Michelle Bachelet’s most popular minister. During a three-year copper boom he and central bank President Jose De Gregorio set aside $48.6 billion, more than 30 percent of the country’s gross domestic product, that he is now using for tax cuts, subsidies and cash handouts to poor families.

The Chilean peso has risen almost 10 percent against the dollar this year to become the best-performing currency among emerging markets. The country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund. While Chile stashed away copper profits, neighboring Argentina boosted spending when revenue from soybean exports rose, leaving it short on cash to stimulate the economy this year.

Velasco, 48, applied the lessons learned from decades of economic failure in Latin America — ones he said could also help the U.S. The current crisis followed “a massive regulatory failure in many advanced financial markets over the last decade or so,” Velasco said in an interview April 21 in his office overlooking the presidential palace in downtown Santiago.

30 Miles a Week

“This is a movie that may be novel to some Americans, but this is a movie that people in other places of the world, Chile included, know we have seen,” said Velasco, who is scheduled to meet April 25 with Federal Reserve Chairman Ben S. Bernanke in Washington. “We know how it begins, how it unfolds and how it ends.”

Velasco, who runs 30 miles (48.3 kilometers) a week, is the son and grandson of national politicians. He received his higher education while living in the U.S. after Augusto Pinochet’s military dictatorship exiled his father from Chile in 1976 for criticizing the regime. Velasco earned a bachelor’s degree in philosophy and economics in 1982 and a master’s in international relations in 1984 at Yale University in New Haven, Connecticut, according to his resume. He received a doctorate in economics from Columbia University in New York in 1989.

“He knew about politics before he knew about economics,” said Patricio Navia, a Chilean political scientist who met Velasco at New York University and still works there.

‘Policy Implications’

Velasco taught economics for most of the 1990s at NYU, according to his resume. From 2000 to 2006 he was a professor at Harvard University in Cambridge, Massachusetts, where he worked with Lawrence Summers, now U.S. President Barack Obama’s National Economic Council director.

“In this world, there are some people who are smart. There are some that are practical,” said Summers. “Andres Velasco is both.”

Before Summers joined the Obama administration, Velasco said, the two men would meet several times a year in Washington and Cambridge.

Velasco is on leave from Harvard’s Kennedy School of Government, where he taught international finance and development. He has an option to return when his period in office ends next March, he said.

Velasco “was always looking for the policy implications of what he was doing, which is very unique,” said Guillermo Calvo, a Columbia macroeconomist who hired Velasco as a teaching assistant. “He was one of the best, but you always sensed that he was going to eventually converge to politics.”

Summers, Calvo and Velasco will be panelists tomorrow at a seminar in Washington examining the effects of the global economic meltdown on Latin America.

Pinochet Exiled Family

Critics of the finance minister’s policies include the man who took in a 15-year-old Velasco on the night Pinochet expelled his father in August 1976.

“He acted like an accountant,” said Adolfo Zaldivar, a Chilean senator and presidential candidate who clashed repeatedly with Velasco. “With that amount of excess revenue, he could have stimulated domestic production. He could have been more creative.”

Chile had about $5.9 billion in treasury holdings when Velasco took a leave from Harvard to become minister in March 2006. By the end of last year, he and the central bank had $48.6 billion to ease the impact of the slump on Chile’s 17 million people. The economy shrank in February by the most since 1999 as industrial production tumbled 11.5 percent.

Commodity-driven swings of boom and bust have defined Latin America’s economic history for the past 100 years.

That is a cycle that needs to be ended,” Velasco said. “We have been out to show that a Latin American country can manage properly, and not mismanage, a commodity cycle. You save in times of abundance, and you invest in lean times.”

Andean Counterpoint

Across the Andes in Argentina, President Cristina Fernandez de Kirchner’s popularity plummeted after she tried to increase taxes on soybean exports. Unresolved lawsuits with investors closed access to international credit markets since the country defaulted in 2001. Middle-class and wealthy families stash thousands of U.S. dollars in home safes in case there is another economic crisis like the one eight years ago.

When Velasco joined Bachelet’s new cabinet in March 2006, the price of copper had risen by more than half in 12 months to $2.25 a pound. Taxes and profits from state-owned Codelco, the world’s largest copper producer, provide about 15 percent of government revenue. Bachelet, 57, Chile’s second consecutive socialist president, came under almost immediate pressure to start spending the revenue.

Students went on strike in May of that year, demanding more money for education. More than 800,000 people protested at high schools and universities, and police with water cannons and tear gas arrested more than 1,000. Velasco reiterated his commitment to “prudent fiscal policies” as politicians from the governing coalition demanded he resign.

‘A Tough Fight’

“He knew at the time that he was getting into a tough fight,” said Ricardo Hausmann, who worked with Velasco at Harvard and runs the university’s Center for International Development. “He was very conscious that he was going to hold his ground because expansionary policies usually end in tears.”

Velasco set up funds to invest the copper windfall abroad, mostly in government bonds. He announced plans to spend the interest from savings on scholarships and helped Bachelet extend social security to 1.3 million people.

In his first three years in office, Velasco posted the biggest budget surpluses since the country returned to democracy in 1990. In 2007, Chile became a net creditor for the first time since independence from Spain in 1810.

Last July, copper reached a record of $4.08 a pound. By year-end, the central bank had built $23.2 billion of reserves. The government had $22.7 billion in offshore funds and about $2.8 billion in its own holdings.

Copper Price Decline

After Lehman Brothers Holdings Inc.’s Sept. 15 bankruptcy sparked a global credit freeze, Velasco and De Gregorio had the equivalent of more than 30 percent of GDP available if needed to shore up Chile’s banks and defend the peso.

The price of copper plummeted 52 percent from Sept. 30 to year-end, and Velasco dusted off his checkbook. In the first week of January, he and Bachelet unveiled a $4 billion package of tax cuts and subsidies.

“He has been vindicated,” said Luis Oganes, head of Latin American research at JPMorgan Chase & Co. in New York, who studied under Velasco.

Chile’s peso fell 0.2 percent to 585.25 pesos per dollar from 583.95 at yesterday’s close.

As well as teaching economics, Velasco ran NYU’s Latin American and Caribbean Studies Center, which allowed him to meet with politicians and writers from around the region. He has published two novels, including a satire about U.S. environmentalists trying to stop a dam in Chile, “Lugares Comunes (Common Places)” (Editorial Planeta), and “Vox Populi” (Editorial Sudamericana).

Political Dividends

Velasco’s stimulus spending, including 40,000-peso ($68.41) handouts to 1.7 million poor families, has paid off politically. His approval rating almost doubled to 57 percent in March from a low of 31 percent in August, according to Adimark GfK, a Santiago-based polling company. He is now the most well-liked member of the government, second only to the president at 62 percent.

People finally understood what was behind his ‘stinginess’ of early years,” said Sebastian Edwards, a Chilean economist at the University of California, Los Angeles. “That explains the rise in his popularity.”

——[End of article]——-

Not all countries necessarily spend their income from a resource boom well

It’s another example of evidence based policy:

  • Latin America (and not only there) has had a centuries old history of resource boom and busts
  • This remedy, saving in boom times and spending (investing!) in bust times, works. The evidence is here.. (and there is a host of evidence that not abiding by these simple rules creates a bevy of problems..).

Tags: Latin America · Public Policy · The World according to Economics