POLICIES TOWARDS THE TRADABLE SECTOR IN CHILE: RECENT HISTORY AND CURRENT DEBATES

POLICIES TOWARDS THE TRADABLE SECTOR IN CHILE: RECENT HISTORY AND CURRENT DEBATES RAUL E. SAEZ International Affairs Coordinator Ministry of Finance, Chile

AGENDA • The importance of the tradable sector in the Chilean economy and in policy-making • Macroeconomic environment • Exchange-rate policy • Trade policy: unilateral liberalization and FTAs • Foreign Direct Investment policy • Competitiveness and private provision of infrastructure and certain government services • The current debate: - The natural resource curse - Investment incentives - Education - Science, research and development

THE IMPORTANCE OF THE TRADABLE SECTOR IN THE CHILEAN ECONOMY AND IN POLICY-MAKING • Share of “traditional” tradable sectors reached 31% in 2002. • Exports of services play an increasingly important role: - 1999 US$ 96 million - 2003 US$ 198 million - Jan-Oct. 2004 US$ 169 million • Share of exports in GDP in 2003 was 36% and in the first semester of 2004, 39%.

THE IMPORTANCE OF THE TRADABLE SECTOR IN THE CHILEAN ECONOMY AND IN POLICY-MAKING • Import-competing sectors face strong competition. Policy approach is neutrality. • Policy is flat MFN tariff; with wheat, wheat flour and sugar as only exceptions. • Ratio of imports to GDP in 2003 was 33%.

THE IMPORTANCE OF THE TRADABLE SECTOR IN THE CHILEAN ECONOMY AND IN POLICY-MAKING • All economic-policy decisions are taken in the context and considering that: 1) the tradable sector, and especially exports, plays a crucial role in economic growth; 2) Chile’s economy is a small and very open economy; 3) competitiveness and higher productivity are the keys for sustaining growth. • Goal is systemic competitiveness of the economy.

THE IMPORTANCE OF THE TRADABLE SECTOR IN THE CHILEAN ECONOMY AND IN POLICY-MAKING • Close cooperation between the public and private sectors to improve the economic environment. • One important example is the Pro-growth Agenda agreed between the Government and the Manufacturers’ Association in January 2002, which includes, among other issues:

THE IMPORTANCE OF THE TRADABLE SECTOR IN THE CHILEAN ECONOMY AND IN POLICY-MAKING 1) Measures to improve competitiveness such as: - Reform of competition policy bodies; - Reform of bankrupcy law; - Modernization of regulation of the telecommunications, fishing and electricity sectors. 2) Measures related to technology policy. 3) Tax measures so as to facilitate the location in Chile of foreign investors’ headquarters for their Latin American operations.

THE IMPORTANCE OF THE TRADABLE SECTOR IN THE CHILEAN ECONOMY AND IN POLICY-MAKING 4) Reform of the capital market to promote the creation of a risk-capital industry, improve information disclosure and allow for more self-regulation of financial institutions. 5) Measures to improve the efficiency of government spending. 6) Elimination of red-tape. 7) Export-promotion actions. Originally limited to reform of drawback and other instruments but has evolved into own private-public working group which covers trade facilitation (both in goods and services), general incentives, access to foreign markets and export promotion.

MACROECONOMIC ENVIRONMENT • Macroeconomic policy framework geared towards insuring stability. • Rules-based policies: - Fiscal policy guided by structural-rule: surplus of 1% of GDP - Monetary policy with target range for inflation: 2-4% • Has allowed reduction of interest rates to stimulate the economy: the average real interest rate for loans over three years was 5.17% in 2003. • Low country-risk: 75 basis points (Global JP Morgan). • Low cost of credit contributes to competitiveness.

REAL EXCHANGE RATE INDEX REI • REI is real exchange rate index with all trade partners; REI-5 is real exchange rate index with the U.S., Japan, the UK, Canada and the six largest partners in the Euro-zone. • Source: Central Bank of Chile REI-5

EXCHANGE RATE Pesos per US dollar. Source: Central Bank of Chile.

EXCHANGE-RATE POLICY • Fully-flexible exchange rate policy since September 1999. • This has resulted in a real depreciation (measured as the relationship between an index of external prices and the consumer price index) and greater volatility of the nominal exchange rate. • Exchange-rate policy is not used to promote the tradable sector. Depreciation is the result of the fiscal/monetary policy mix. • To face short-term volatility, exporters are encouraged to use market-provided hedging instruments.

TRADE POLICY:UNILATERAL LIBERALIZATION AND FTAs • Since 1974, the promotion of the exportable sector in Chile has been based on the reduction of tariffs and elimination of other restrictions on imports. • The MFN tariff has been set at a flat rate since 1979. It reached 6% in 2003, but the average applied tariff was less than 2% at the beginning of 2004 as a result of trade agreements. • The effect of unilateral trade liberalization was what theory would predict: development of activities in which Chile has a comparative advantage, and shrinking of those activities in which there is no comparative advantage.

TRADE POLICY:UNILATERAL LIBERALIZATION AND FTAs • The basket of exports has become more diversified and the number of countries of destination has increased. Chile has no dominant or “natural” export market. • The vulnerability to shocks in the price of copper has been reduced as well as to the economic cycle of specific regions of the world.

TRADE POLICY:UNILATERAL LIBERALIZATION AND FTAs • Until 1990, trade policy was based only on unilateral elimination of trade barriers. • Starting in 1990, an active policy of negotiating FTAs was implemented as a complement to unilateral liberalization. • As a result, about two thirds of Chile’s exports are covered by a bilateral trade agreement.

TRADE POLICY:UNILATERAL LIBERALIZATION AND FTAs • The main objectives of negotiating FTAs has been to improve market access, both in terms of facing lower or no barriers and reducing uncertainty regarding the conditions of such access. • This has been through the elimination of tariffs which, as a collateral result, should eliminate tariff escalation, and the scrapping and/or regulation of non-tariff restrictions.

FOREIGN DIRECT INVESTMENT POLICY • The basic premise has been neutral policies towards direct foreign investment. • Only benefit is a guarantee of tax invariability for those investors that use DL 600. • Debate over whether incentives should be used to attract investment in high technology industries. • Recently grants for the co-financing of activities related to investment activities in high technology sectors have been introduced. • Chile does not use performance requirements. Furthermore, now the FTA with the U.S. limits their use.

FOREIGN DIRECT INVESTMENT POLICY • Active search for establishment of regional call centers and shared-services centers. • Attractiveness based on low cost of telecommunications, high levels of connectivity and quality of life. • Limitation: Human capital availability.

COMPETITIVENESS AND PRIVATE PROVISION OF INFRASTRUCTURE AND CERTAIN GOVERNMENT SERVICES • Competitiveness and the development of the tradable sector requires appropriate infrastructure so that exports can reach ports of exit at the lowest cost possible. • In the second half of the 1990s, Chile began a massive process of transferring roads to private operators through BOT contracts. • The government has also been transferring the operation of docks at major ports to private enterprises, maintaining the overall management of the ports. • More recently, other services, such as the building and operation of prisons, is being transferred to the private sector.

THE CURRENT DEBATE IN CHILE • Natural resource curse? • Concentration in natural resource-based exports does not mean that Chile only exports commodities. Wine and salmon are two major examples. • Fresh fruit is also another example if one includes all the sophisticated services associated with exporting it. • Even in the case of copper, and mining in general, an industry of providers, some of them with innovative products, has developed. • But, is it enough to sustain growth?

THE CURRENT DEBATE IN CHILE • Some research indicates that natural-resource abundance reduces growth: - Rent-seeking activities - Dutch disease - Little or no linkages to domestic economy • But, there is also research that shows that that natural-resource abundance affects negatively growth only in countries with low levels of human capital. • The issue that Chile faces can be illustrated with the following diagram.

COMPOSITION OF EXPORTS IN 2002 Source: Estado de la Hacienda Pública 2004, Ministerio de Hacienda de Chile.

THE CURRENT DEBATE IN CHILE • Looking at developed countries relatively rich in natural resources (Finland, Sweden, Australia and New Zealand). • Three basic issues: 1) High levels of human capital can interact with natural resource endowment and lead to high growth; 2) Capacity to innovate: - R&D/GDP Finland 3,4% Sweden 4,3% Chile 0,6%

THE CURRENT DEBATE IN CHILE - Number of patents per year per 1 million persons Finland 180 Sweden 195 Chile 1 - Innovation around natural resources 3) Appropriate institutions, respect of contracts and property rights, rule of law, development of capital market, in particular seed capital, coherent economic incentives.

THE CURRENT DEBATE IN CHILE • Incentives for Direct Foreign Investment • Education • Science, research and development Funding through royalty on mining

POLICIES TOWARDS THE TRADABLE SECTOR IN CHILE: RECENT HISTORY AND CURRENT DEBATES RAUL E. SAEZ International Affairs Coordinator Ministry of Finance, Chile

POLICIES TOWARDS THE TRADABLE SECTOR IN CHILE: RECENT HISTORY AND CURRENT DEBATES