Pinochet Aside, Chile’s Reforms Launched a New Era

The military retirement last week of Gen. Augusto Pinochet of Chile was a useful reminder of the forces that over two decades have produced the leading trends in the world economy--and ultimately contributed to the sky-high U.S. bull market.

In a sense, it all began in Chile, which in the early 1970s was one of the first economies in the developing world to test such concepts as deregulation of industries, privatization of state companies, freeing of prices from government control and opening of the home market to imports. In 1981, Chile privatized its social security system.

Many of those ideas, formulated at the University of Chicago by Milton Friedman, Arnold Harberger and other economists, later changed the economies of neighboring Argentina and Brazil and ultimately spread throughout Latin America and to the rest of the world.

They are behind the reformation of Eastern Europe and the states of the former Soviet Union today. In some measure, Chilean economics are the prescription for bringing ailing Asian economies back to health, even as Asia’s troubles threaten Latin American economies.

There are ironies, to be sure. Ideas of economic freedom took hold in an atmosphere of political repression. In Chile, the Chicago school got to try its ideas after the 1973 coup led by Pinochet, which overthrew the regime of Salvador Allende, who had nationalized industries and attempted to set up a Socialist state.

Allende died in the coup and Pinochet went on to rule for almost two decades in a violent dictatorship in which 3,000 Chileans died or disappeared and thousands more went into exile.

But the Chicago economic ideas were not part of the oppression. On the contrary, the fulfillment of their open-market concepts helped lead the country to its current democracy, which began in 1989 after Pinochet--in an uncommon move for a dictator--asked the people to vote in a plebiscite whether he should continue ruling and was rejected.

In any event, Chile, a country of 14 million people, set a new model for the world because of its economics, not its politics. In the 1970s, the concept of a developing country using free markets was “exotic,” says Sebastian Edwards, a Chilean economist who helped devise some of his country’s reforms in the 1980s and now teaches at UCLA’s Anderson School of management.

The conventional wisdom was that planning, import restrictions and state control of the economy’s key industries were necessary for development. Even the U.S. government controlled oil and gas prices in the 1970s, believing that free markets would lead to chaos.

Such systems didn’t work. State controls produced more government jobs than industrial output. Taxpayers groaned, economies stagnated.

Chile demonstrated a new model, although a faulty one at first. In the 1970s, it sold off state banks too cheaply, allowed companies to be bought up with low-interest loans until the whole arrangement collapsed--as similar structures have done lately in Asia.

But in the 1980s, Chile set up a pension system requiring all workers to contribute 15% of their pay, with employers contributing matching amounts. The money was invested in Chilean industry rather than government bonds like U.S. Social Security funds. And industry was transformed by stockholder values. “We spread stock ownership. Workers could buy company stock at a discount,” Edwards says.

Traditional, family-owned conglomerates had to slim down and become more efficient under pressure from stockholders and competition from imports. Chile’s economy took off, growing at more than 6% a year in the late 1980s, inspiring economic change in Argentina and Brazil.

As South American companies improved, they reached out to the world for capital. Chile, an economy of only $70 billion in total output, has 18 companies listed on the New York Stock Exchange, including Compania Telecommunications de Chile; its pension system Pensiones-Provida; and its chief wine exporter, Vina Concha y Toro.

Add to that 10 Argentine firms--including YPF, the former state oil company, and several Brazilian firms, including Telebras, the telecommunications utility--and South America has as many companies listed in New York as the better-known economies of Asia.

“When utilities in South America are privatized, there are immediate gains in productivity as they cut waste and excess staff,” notes Mark Beveridge, the Ft. Lauderdale, Fla.-based portfolio manager of Templeton’s Latin America fund.

But the lessons of Chile and South America go beyond cost-cutting. The important factor was fresh, adaptable thinking. Chile, for example, discourages short-term global capital by penalizing investments of less than one year. It wants commitments to industry, not quick hits. And many countries of Asia that have been hurt by fast money movements might study Chile.

Also, as South Korean corporate giants face restructuring, they might take a look at how Chile’s family-owned companies got in shape.

Still, there is peril in Latin American economies today. Low-priced imports from troubled Asian economies could displace Latin American goods on world markets or even hurt local producers in home markets. Financial experts have been worried that Brazil--South America’s largest economy at some $900 billion in output--will have to devalue its currency, the real. That would create grave troubles for all of Latin America and beyond.

But in fact Brazil’s economy has withstood the early uncertainty from Asia and is improving, says Robert Pelosky Jr., regional analyst for Morgan Stanley. To be sure, interest rates are 28% in Brazil, indicating a still-developing economy. And Chile is being hurt by the effect of Asia’s slowdown on the price of copper.

Yet those normal troubles are not deterring any of the countries from open-market policies. “The fundamentals of Latin American economies are attractive growth and deepening structural reform,” Pelosky says.

What is really happening is that the world’s perception of once-unstable South American countries has changed, thanks largely to reforms begun in Chile in the 1970s. Which should demonstrate once again, for skeptics in business and finance, the awesome power of ideas.

James Flanigan can be reached by e-mail at jim.flanigan@latimes.com