Chile’s Paradox of Prosperity

Thirty years ago, as Latin America was succumbing to the debt crisis, few nations suffered as much as Chile. The country still bore the scars of the bloody military coup that claimed the lives of former president Salvador Allende and some 3,000 supporters a decade earlier. The debt crisis hit when the economy was undergoing wrenching change from the radical free-market policies pursued by the regime of General Augusto Pinochet. The results were painful: Economic output collapsed by 14 percent in 1982, unemployment soared to more than 30 percent, nearly half the population lived below the poverty line, and the current-account deficit was running at a rate of 12 percent of GDP.

Today, Chile stands transformed. The country experienced only a mild recession in 2009 and has bounced back vigorously, with growth averaging more than 5 percent a year for the past three years. Unemployment dropped to just 6 percent by the end of 2012, and Chile’s reserves, swelled by copper export earnings, rose to some 20 percent of GDP. The country’s leading banks, retailers, airlines and other companies are now expanding aggressively across Latin America, avatars of Chile’s growing confidence. On current trends, Chile will become the region’s first developed nation by the end of the decade.

In a meeting symbolic of the country’s ascendance, Chile hosted heads of government from more than 40 Latin American and European Union countries in January. The gathering underscored the shifting economic balance between the vibrant emerging markets of the New World and the recession-mired Old World nations, with Spanish Prime Minister Mariano Rajoy appealing to Latin leaders to invest in his country.

For President Sebastián Piñera, Chile’s robust economic health is a source of tremendous pride. “This was the poorest of Spain’s former New World colonies, and now it is the one with the highest per capita income,” Piñera told Institutional Investor in an interview on the eve of the summit meeting.

The sentiment is broadly shared by the president’s conservative supporters, especially in the business community. “For businesspeople of my generation, there is a widespread feeling that we are living through the greatest period of Chile’s economic history,” says Jorge Errázuriz, one of the country’s leading investment bankers.

Prosperity hasn’t solved all of Chile’s problems, though. Discontent over economic inequality has bubbled to the surface during Piñera’s administration, fed in part by the perception that the president, a billionaire businessman before taking office, is a servant of the wealthy. Student-led demonstrations have rocked Santiago, the capital, over the past two years, and according to public opinion polls, Piñera’s center-right government is the most unpopular one since Pinochet’s 17-year dictatorship ended in 1990.

The contradiction of economic well-being and social unrest has drawn the attention of policymakers throughout the region. “More and more, people are looking to Chile, for two important reasons,” says Luís Alberto Moreno, president of the Inter-American Development Bank. “There is the quality of their public policy debate and also the way Chile goes about dealing with the so-called middle-income trap.”

Many big Latin American countries achieved middle-income status in the 1960s and ’70s only to stagnate for a generation from the combined effects of the debt crisis, economic mismanagement and social and political strife. The phenomenon isn’t only a Latin one. Since the ’60s scores of less developed countries have managed to rise to middle-income levels, generally defined as per capita income of between $2,000 and $12,000 a year. But only a handful — including Greece, Israel, Portugal, Singapore, South Korea and Spain — had succeeded in joining the ranks of developed nations by the year 2000. “The rest got derailed,” says Chile’s Finance minister, Felipe Larraín. “Popular expectations rose too quickly. People believed their country was doing well and they should receive more economic benefits. And governments gave in.”

There is plenty of evidence to suggest that the sheer momentum of Chile’s economy will inexorably lift the vast majority of its 17 million inhabitants into middle-class security. Chileans already enjoy a per capita annual income of $19,000 on a purchasing power parity basis, the highest in the region. That’s within reach of the $24,000 level that the World Bank regards as the key measure of a developed economy.

During the three years of Piñera’s presidency, which began in March 2010, economic growth has accelerated to nearly double the rate that prevailed under his center-left predecessor, Michelle Bachelet. The economy has created 1 million jobs in that period, a number that is equivalent to some 18 million in the U.S. Wages have grown at a pace of more than 2 percent a year in real terms. Inflation is running at a rate of just 1.5 percent, well below Brazil’s, at 6 percent, and Argentina’s, which is unofficially estimated to be running at 30 percent.

Evidence of growing prosperity is everywhere. During the day construction cranes rise above the Santiago landscape. At night the traffic-clogged freeways turn into rivers of headlights. Restaurants and clubs are jammed, with long lines of customers waiting outside. A record 8 million Chileans, nearly half the population, vacationed at the beaches and in the countryside last year; that was twice the total for 2011.

Not even the terrible earthquake of 2010 — the fifth most powerful ever recorded on the planet, claiming 550 lives and causing some $25 billion in damage — was able to slow the economic surge.

A helicopter flight in mid-January over some of the most damaged zones, 150 miles south of Santiago, revealed the impressive scale of reconstruction. On a similar flight two years earlier, one could see countless houses, office buildings, bridges and other infrastructure flattened by the quake. This time almost all of those structures had been restored or rebuilt. According to government statistics, 75 percent of the 222,413 homes damaged by the quake nationwide have been repaired or rebuilt with government subsidies. Overall, the government asserts, 85 percent of damaged and destroyed infrastructure has been restored.

Behind Chile’s remarkable transformation lie decades of disciplined macroeconomic policy. “The Chileans started their economic reforms far earlier than any other country in the region, during the military government of Pinochet,” says Claudio Loser, a Washington-­based senior fellow at the Inter-American Dialogue and former head of the Western Hemisphere department at the International Monetary Fund.

As brutal as Pinochet was, even the left-of-center governments that succeeded him embraced his economic policies. That monetarist, free-market model was fashioned by a group of Chilean economists known as “the Chicago boys” for having studied under Milton Friedman at the University of Chicago. On their advice, Pinochet privatized everything from farms, factories and banks — many of which had been nationalized by the Socialist Allende — to the social security system. He lifted trade barriers to force Chilean businesses to compete with imports and sell their goods abroad. And his regime forged what is now the leanest bureaucracy in Latin America, one that regularly runs budget surpluses.

At the end of last year, the private pension funds that have largely replaced social security contained $165 billion, or more than 60 percent of GDP, a huge domestic savings pool for Chilean businesses. Borrowing from abroad is helped by Chile’s AA– credit rating from Standard & Poor’s — on a par with China’s and well above the BBB ratings of regional peers like Brazil and Mexico. And last year Chile received $26.4 billion in foreign direct investment, second only to Brazil in Latin America.

Despite the glowing economic statistics of his presidency, Piñera himself remains widely unpopular. Only a year ago public opinion polls gave his government less than 25 percent support — as low as Pinochet ever received. Lately, his standing has recovered modestly, to as high as 36 percent. “It’s a paradox,” he says. “Our citizens have become very demanding and impatient.”

The loudest complaints come from Chile’s universities, where a student protest movement has become the vessel of rising popular expectations, especially in the burgeoning middle class. The number of students has quintupled, to 1.1 million, over the past 20 years, and dozens of private universities have sprouted to accommodate those who are not admitted to public institutions. But in 2011 and 2012, large-scale demonstrations rocked Santiago as students protested high fees and low-quality education. According to polls, they have the backing of as much as 70 percent of the electorate.

A trio of student activists from the University of Chile Law School recently gathered at the home of a professor to discuss the movement’s grievances. At the top, they listed tuition that averages $400 a month, equivalent to the legal minimum wage. “Parents get crushed by these costs,” says Juan Francisco Lobo. “And that explains why our movement has such wide support.”

The students say they want nothing less than free tuition at publicly supported universities. They also demand an end to dubious deals under which owners of government-­subsidized private universities create development companies to compensate them for the use of school buildings. “It has always been against the law for state-aided universities to make profits,” says Gonzalo García, another of the student activists.

According to a third student, María Victoria de Marchi, the protest movement has finally ended the political docility ingrained since the Pinochet era. “We’re too young to have lived through the dictatorship,” she says. “So we don’t have any of the inhibitions of our parents’ generation.”

The government has demonstrated flexibility. Over the past three years, it has increased the education budget by 50 percent, to $12.8 billion. Almost two thirds of students receive government scholarships or loans that cover about 75 percent of tuition and other fees. Most loans carry a subsidized interest rate of only 2 percent and a guarantee that after graduation no students will have to make repayments that exceed 10 percent of their annual incomes. “But we don’t think it is fair to offer free higher education to those students who can afford to pay,” says Piñera.

Chile’s beefed-up education program has taken some of the wind out of the protest movement’s sails. The last large student demonstration took place on June 28, 2012, with as many as 100,000 protesters on the streets of Santiago. Earlier that month, only a half mile away, some 200,000 shoppers jammed into Costanera Center, the city’s newest mall, for its opening-day sales.

The student protests have nonetheless become a potent battering ram for those discontented with social inequality. Over the past generation Chile has managed to reduce its poverty rate from 45 percent of the population to the current level of 14.4 percent — half the poverty rate for Latin America as a whole. But Chile’s skewed income levels have left the country at the region’s average in terms of economic inequality, according to data from the Organization for Economic Cooperation and Development. Among the 31 OECD members, Chile has the most unequal income distribution.

Chile’s elite never possessed the huge farming estates of the Argentinean estancieros or the flamboyant personalities of Brazil’s billionaire class. Yet nowadays a small group of the newly affluent fills the press with photos of themselves riding on polo ponies, yachts and helicopters. “I feel like I’m living in a village,” says Errázuriz, co-founder of Celfin Capital, the most prominent Chilean investment bank. “The faces in the magazines and newspapers are always the same people I knew from my university days and early career.”

Most Chileans feel that Piñera’s government, the first conservative administration since democracy was restored in 1990, represents the elite more than the middle class.

Piñera, a self-made broadcasting and airline billionaire, won the 2010 presidential election by promising to run the government as successfully as he did his businesses. But that’s no longer a slogan that any of his would-be successors wants to campaign on.

The likely conservative candidate in the November 2013 election is Piñera’s former minister of Public Works, Laurence Golborne. He made a fortune as a retailing executive but prefers to emphasize his lower-middle-class roots. Yet the polls show that he would be trounced by former president Bachelet, a Socialist who is widely expected to seek a return to La Moneda, the presidential palace, even though she hasn’t yet declared her candidacy or returned to Chile. She lives in New York, where she is executive director of  UN Women, the recently created United Nations agency to promote women’s rights worldwide.

Golborne concedes the difficulty of running against a popular, undeclared opponent. “The biggest frustration has been the low public acknowledgment of this government’s economic achievements,” he says. “Abroad these achievements are widely recognized, while in Chile few people are giving credit to President Piñera.”

According to Golborne, the lack of popular support stems from a still-insecure middle class. “They have left poverty behind, but many of them fear that any downturn in the economy will land them back where they were,” he says. His solution would be to launch a government-supported homebuilding program for the aspiring middle class, especially younger Chileans. “We did a great job in rebuilding the country after the awful earthquake of 2010,” says Golborne. “Now we have to cope with a social earthquake — all those people with no homes of their own and who have to live with their families or double up with friends.”

Another economic debate in Chile as it heads toward full development status is how to reduce dependence on the mining sector. Copper accounts for some 60 percent of export earnings, even after two decades of growth in agricultural, fishing and industrial exports. “I wish it weren’t so,” says Gonzalo Menéndez, senior director at Luksic Group, owner of the largest Chilean private mine. “We would all love to see another sector gain relative strength in the GDP.”

But those nonmining businesses that contributed to a cycle of growth and wealth creation over the past 15 to 20 years are now maturing. “Chileans have to increase productivity, reinvent themselves and find new industries,” says Alberto Ramos, senior Latin America economist at Goldman Sachs Group in New York.

Nicolás Shea, who earned an M.Sc. in management from the Stanford Graduate School of Business, is one Chilean who has taken up the call to create new businesses. Impressed by Silicon Valley and stunned by the immigration barriers that the U.S. erected in the wake of the September 11, 2001, terrorist attacks, Shea persuaded Chile’s Ministry of Economy, Development and Tourism to finance a nonprofit agency called Start-Up Chile. The organization, which Shea opened in 2010, offers Chilean and foreign entrepreneurs free office space and a $40,000 grant to launch their firms. The hope is that within a decade, Chile will have its own version of Silicon Valley and become a hothouse of high-tech and web-based ventures.

“Because Chile is such an outward-­looking, globally connected and open economy, it’s a great market for start-ups to test their products and services,” says Shea, who remains on the board of Start-Up Chile but has gone on to fund Cumplo, an online bank for new small businesses.

By February the number of start-ups had reached 602, of which only 138 are Chilean. These firms are collectively worth more than $50 million, according to Start-Up Chile. The new ventures run the gamut from providers of last-minute cruise offers (CruiseWise) to instant voice translations (Babelverse) to odor-absorbing shoe liners (Chu Shu).

ClubPoint, an online shopping company co-founded by three Argentineans, is one of the star graduates of Start-Up Chile. Launched in the second half of 2011, the company runs on a membership model that offers its members discounts on leading brands of clothing, accessories and cosmetics from around the world.

In January, the height of beach season, ClubPoint featured a popular brand of sunglasses at a 50 percent discount. “We have a strong database and quickly build up a client history so that we can offer a member products of interest,” says Juan Pablo Torras, 27, one of the three co-founders, who splits his time between Buenos Aires and Santiago. “Every week we add or drop new brands.”

ClubPoint pursues different strategies in Chile and Argentina. In Chile, which has no trade barriers, members are offered international brands almost exclusively. In Argentina, where luxury imports are barred or onerously taxed, only national brands are available.

Thus far, ClubPoint investors have put up $180,000. Already, monthly revenues have reached $300,000 and net profits are running at 6 percent of sales. But ClubPoint believes the greatest growth lies ahead with its entry into the Brazilian market this year. “We are projecting 500 percent annual growth over each of the next four years, mainly because of the potential of Brazil, which is a huge market,” says Torras. “We are aiming at $100 million in revenues by 2016.”

Natália Monteiro, founder of another Start-Up Chile company, Zuggi, an educational website for children six to 12 years old, is already operating in Brazil. Monteiro, 27, a São Paulo native, launched her company in Chile in the second half of 2012 before moving back to Brazil.

Zuggi offers video games and a social network to elementary school kids. “We are trying to make learning a fun process for the children, while allowing parents and teachers to track their development,” says Monteiro. Zuggi has pioneered filters that steer children clear of inappropriate websites or images and ensure that their social networking won’t access anybody but kids they personally know.

Besides the financing and office space she received, Monteiro considered Chile an attractive market because of its large middle class and widespread computer ownership. Eight out of ten Chileans under 30 are on Facebook, and 30 percent use Twitter. The much larger Brazilian market looms ahead, followed by other Latin American countries.

Monteiro, who is in the process of raising $1 million for expansion into Brazil, expects Zuggi to become profitable in the second half of this year. She is aiming for $2 billion in annual revenue, mainly from subscriptions, by the second half of this decade, with the Brazilian market accounting for 40 percent.

Can Start-Up Chile develop into Chile­con Valley? That depends on whether the next government is right or left of center. Bachelet supporters are less inclined to use public subsidies for the private sector and more enthusiastic about higher taxes. Chile’s tax intake is 17 percent of GDP, about equal to the Latin American average but modest for an emerging-markets country with such a high per capita income. By contrast, Turkey raises 32.5 percent of GDP in taxes, Poland 34.3 percent and Romania 28.1 percent.

A return to center-left government might slow down economic growth while distributing an additional $10 billion a year to lower-income sectors. But not even conservatives assert that such an election outcome will block Chile’s first-world ambitions. “The middle class is this country’s fastest-growing segment, and its concerns go beyond basic needs, to better jobs, salaries, housing and education,” says former minister Golborne. “These are more the concerns of a developed nation than an underdeveloped one.”