The Chilean miracle

Tim Congdon

Chile has been portrayed as a small, remote and unhappy country where a terrified population submits reluctantly to a grisly military dictatorship. The pariah image has been made easier to convey by its economic policies, which are deemed, rightly or wrongly, to be more monetarist than anywhere else in the world. 'Monetarism' has become a favourite 'boo-word' for professional communicators, particularly in Britain.

Chile is therefore an ideal target for the numerous polemical bullies of the 'wee liberal establishment. For example, in February last year Professor Kenneth Galbraith, while staying at the Ritz on a short visit to London, wrote a letter to The Times which bracketed together the economic policies — and supposedly the economic disasters — of Britain, Israel and Chile. It was a masterly blend of banter and sneer. Galbraith began by noting what a pleasure it was 'to come to London in this otherwise wintry season and find the crocuses and also Professor Milton Friedman in full bloom'. But he wondered whether Friedman was entirely content. If monetarist ideas were put into practice, they might not work. 'In past times my friend has undertaken, as in the case of Israel and Chile, to detach himself when his disciples made things worse: the Israelis were insufficient in the faith, the Chileans reprehensively oppressive, however good their economic intentions. But such has been the British embrace that this will not be possible. Professor Friedman will surely agree, he is now fully and fairly on trial.'

There are some nice conceits in this letter. For example, to compare the situation of either Chile or Israel to that of a mature industrial country like Britain requires rather more analytical circumspection than is possible in correspondence to The Times. But Galbraith seems to think he is on safe ground in citing Chile as a demonstration of the failure of Friedmanite policies. Even if the policies had worked, no one would dare to say so. Whatever success they might have could be attributed to the 'reprehensively oppressive' government behind them rather than their intrinsic economic merits.

As it happens, news of the Chilean economy has begun to filter through into publications like controlled-circulation magazines for international bankers. It is not the sort of news 'wet' liberals like to hear. The July issue of the free and glossy Institutional Investor quoted one banker who thought Chile was 'the jewel of Latin America from a performance standpoint' and another who judged: 'It's difficult to find anything done wrong by their economic team'. Galbraith would no doubt scoff at both the publications and the bankers. After all, they have only money at stake.

But it is hard to see how Galbraith can scoff at the facts. In the twelve months to December 1973 the Chilean wholesale price index rose by 1,147.1 per cent; in the first five months of 1981 it rose by 0.4 per cent. As the Chilean government's prime objective over the last eight years has been to reduce inflation, only one comment on their sound money policies is possible. They have been an astonishing success. Indeed, the turn-around is all the more extraordinary in relation to the past record. Over the 30 years from 1950 prices went up faster in Chile than in any other country. But in the first half of 1981 Chile's inflation — as measured by the wholesale price index — was the lowest in the world.

It would be rash to place too much emphasis on this, as the 'wholesale price index' in Chile means something different from the 'wholesale price index' in other countries. Retail prices have increased rather more quickly in 1981, at about 1 per cent a month. But one does not need to be a statistical wizard, a Harvard professor or even a guest of the Ritz to appreciate that something remarkable has happened. From being a textbook example of how hyperinflations continue, Chile has become a textbook example of how inflation should be controlled.

The most important single reason for the transformation has been the elimination of the budget deficit. In 1973 the government had a budget deficit equivalent to almost 25 per cent of national income; today it has a budget surplus. As a result, it never has to raid the central bank for money to cover its excess expenditure. (Indeed, it is now unconstitutional for the government to borrow from the central bank.) Instead, the central bank has been able to pile up substantial reserves of dollars, other foreign currencies and gold. With these resources available it has been possible to maintain the Chilean peso at a fixed exchange rate with the dollar. When the dollar soared on the foreign exchanges in early 1981, so too did the peso. As in the US, but more so because of the responsiveness of the small Chilean economy to international forces, the price of imports fell and the inflation rate tumbled.

There were very heavy and unpleasant social costs in this process, as both the 'wet' liberals and the monetarists would have predicted. In early 1976 the unemployment rate had soared to 22 per cent. But they were also transient. In the last five years, unemployment has fallen steadily, so that It is now 81/2 per cent — not much above the Sixties average of 6 per cent. The total number of people at work in Chile is at present higher than ever before.

The Chilean success with inflation is just another example of the old-time religion of balanced budgets and monetary restraint. Galbraith has had much fun in mocking its devotees as if they were members of a weird and wrong-headed moral rearmament cult. Friedman himself has come in for much of the scorn. We can be fairly certain that Galbraith would dispute the connection between the Chilean authorities' financial policies and their inflation achievement. No doubt he would instead attribute the attainment of stable prices to their 'reprehensively oppressive' approach to law and order. To put Galbraith's position at its crudest, there is no correlation between prices and money, but only between inflation and a government's expenditure on jackboots and tanks.

There is an easy test of the Galbraithian theory of inflation. It is to compare Chile with its neighbour, Argentina. In March 1976 the military captured power in Argentina and since then it has incurred almost as much odium as Pinochet's regime in Chile. With the publication of Timerman's Prisoner without a Name, Cell without a Number, which seems likely to become a minor classic about political tyranny, it is possible that Argentina will in due course be even more stigmatised for violation of human rights.

But these are not the only similarities between the two countries. The 1976 military coup in Argentina, like that in Chile nearly three years earlier, took place in an environment of economic anarchy. It was less that the government had ignored the principles of economics than that it had forgotten the laws of arithmetic. The rate of price increases was running at 600 per cent a year against a background of explosive money growth. The crazy inflationary merry-goround was fuelled by a budget deficit amounting to 15 per cent of national income.

But Argentina did not approach its problems in the same way as Chile. In Chile the methods applied were drastic and uncompromising. Despite domestic protest against and international disapproval of large Public expenditure cuts, the budget deficit was stopped in two years. In Argentina, by contrast, the military regime's programme was much more gradual. The fear was that vigorous action might cause an unacceptable increase in unemployment. Although the budget deficit was lowered to 4 per cent of national income in 1979 and 1980, enabling the inflation rate to drop briefly beneath 100 per cent in early 1981, the process of stabilisation went no further.

There was no determined attempt to balance the budget or move into surplus. Eventually the temptation for the government to borrow from the central bank became irresistible. By March 1981 the printing presses were hard at work, money growth was accelerating and public confidence in the government's financial policy had disintegrated. The Argentine currency was devalued by 30 per cent on 1 April and has since been devalued by much more. The rise in prices this year may approach 150 per Cent.

A 'reprehensively oppressive' approach towards law and order — or towards the trade unions, for that matter — cannot solve the problem of inflation. Ironically, the failure to stabilise the Argentine economy was largely the result of excessive military expenditure. The sound money technocrats were able to curb the civil servants and the managers of public enterprises, but they could not argue with generals and admirals. Their efforts to balance the budget were always frustrated by more spending on toys for the military.

The comparison between Chile and Argentina over the last six or seven years provides an almost unique experiment for the social scientist. In near-perfect laboratory conditions, the Friedmanite and Galbraithian theories of inflation have been 'fully and fairly on trial'. The Galbraithian theory does not emerge with much plausibility. There is no link between 'reprehensive oppression' and a country's inflation rate; there is no correlation between a government's expenditure on military playthings and the restoration of sound financial conditions. If anything, the correlation is in the wrong direction. The more that generals spend on jackboots and tanks, the bigger the budget deficit and the harder it is to overcome inflation.

But Friedman's theories have been proved emphatically right. Perhaps nowhere have they been more in 'full bloom' than in Chile and nowhere have they worked with so little ambiguity. Governments which run big budget deficits will also have runaway money supply growth and runaway money supply growth will be followed by inflation; governments which balance their budgets will find it easier to check monetary expansion and slower monetary expansion will permit a return to price stability. These simple rules apply to Argentina, Chile, Israel and Britain. Letters to The Times, even when written in the Ritz and despite their eloquence on the subject of crocuses, will not change them.