Public Policies for Investiment in Human Capital: The Case of Chile 1990-2000

1. Public Policies for Investiment in Human Capital: The Case of Chile 1990-2000 Eduardo Aninat former Finance Minister of Chile (1994-1999) former Deputy Managing Director IMF Draft Version November, 2003

2. The Political Context for Economic Policy Making in Chile of the 1990’s Concertación Alliance came to power in 1990: One of the key issues in its program platforms for the political agenda was centered on the so-called “social debt” (inherited of Pinochet’s period.) In part, the success of the strategy for rallying an important part of the votes to favor the democratic coalition of Concertación was based in a set of pledges, regarding the resolution, through time, of such social issues in the new democracy of Chile. There was a genuine fear that acting too boldly and too fast in this area would generate all kinds of pressures in the system, risking unbalanced macro economics and a subsequent hit on inflation (still running at two digits) or on the rate of sustainable economic growth and on external balances.

3. Structural Elements in Chile’s High Rate of Economic Growth: A Synthesis • Early and strictly time consistent option followed in favor of an open-to-trade economic model: • Lliberalizations done in the foreign trade regime in Chile around 1975- 1979 • Consistent deepening and broadening during the late eighties and the decade of the nineties (1990-2000) • Domestic institution building: Chile can be characterized as a small, open economy country, which has generally been careful and respectful for domestic economic institutions: • Legality, constitutionality, and presentation and consolidation by the Legislative Branch of Government and other institutions, has almost generally been the norm • The most salient part of this long haul of institutional build-up exists in the social servicesw area, particularly on the education area.

4. The Political Economy of Public Social Policies in Chile: Revealed Preferences and Pressure Groups • The deep recession experienced by Chile in 1982-84 coupled with the very imperfect domestic policy responses (government of Pinochet) had generated important losses in the standards of living of the middle class and of the poor. • This created a cumulative backlog of unfulfilled demands from many organized groups, clusters that were normally associated to voters for the Concertación alliance. • The government of Patricio Aylwin (1990-1993) had made one important effort on redressing part of the decline, in both absolute and relative levels, for expenditures directed to some key areas of the social services. • The well intended and reasonably well designed efforts by the Aylwin’s administration in social matters were then considered clearly not enough.

5. The Political Economy of Public Social Policies in Chile: Revealed Preferences and Pressure Groups • The economic agenda of the second candidate of the Concertación,Eduardo Frei, again had to include an extensive list of new social programs and new reforms in the area of social services. • Due to prior historical experiences, and from the sheer estimated size of “social demands” arising, a kind of “ordenateur” was to be searched (a mechanism or a special agenda, to put-in-line these factors in a reasonably orderly and coherent way, one that would not impinge negatively on macroequilibria.) • After months of discussion inside the Cabinet, it was suggested by the Ministries of Finance and Education to then President Frei, that it was best to focus on an Education Reform process, and to launch early in his period (1995 – 1996). These reform area could act as the principal ordenateur.

6. The Political Economy of Public Social Policies in Chile: Revealed Preferences and Pressure Groups In the table that follows next, we get a summary on first the big decline between ninety seventy and nineteen ninety, and the subsequent recovery and redressal in per capita public spending for education; the series is compared with the evolution of average wage rates in the private sector.

7. Educational Reform: The Story of Contents of the Reform • President Eduardo Frei Ruiz-Tagle indicated that his administration would grant priority to improve the quality of education in Chile. • The National Commission of Modernization of Education was born, integrated by 18 professionals and academics, coming from diverse activities and having different political positions.Their mission was updating a complete diagnosis of the educational system, including its main deficiencies and limitations.

8. Educational Reform: The Story of Contents of the Reform According with the Education Reform proposed, it would be fundamental to spend more time in learning, in order to improve in human capital knowledge. • Advantages for the extension of the school day were evident: • It would cause unquestionable education benefits • Have positives social effects, specially supporting low income families, in a context of parents (both heads of households) increasingly working outside their homes. • It would contribute to school management improvement (professors could then concentrate their work preferably in a single school establishment, helping thus to build cohesion in the educative project of each.)

9. Educational Reform: The Story of Contents of the Reform • Different alternatives were examined for the transition to an extended school schedule system. To enter gradually, in to the new schedule of a “Complete Journey spent at the School (JEC, in Spanish) was the general pivotal case. • Starting in 1997, Chilean Education Reform had evolved to get its fundamental structure. • The government of President Frei, at our explicit proposal from the Treasury, aimed at financing the core new expenditures involved in the Reform, via the maintenance or consolidation of the Value Added Tax (VAT) rate, at its then established value.

10. Educational Reform: The Story of Contents of the Reform PRIOR RESULTS OF THE COMPLETE JOURNEY AT THE SCHOOL (JEC) The increase in school journeys (JEC) will in fact mean that those students who attend all of their basic education and secondary schooling with this system attend two more years of classes. This is very significant, compared with the situation of students who did not reach the benefit of being part of the reform process. In this way, the JEC changed the scheme towards a new more intense modality. It implied that all the students go to classes throughout the “full” school day. Educational work has more effective time, so the reform could have (potentially, at least...) the maximum desired effect.

11. The Financing of Social Policies in Chile: A Public Finance Perspective The implementation of more active social policies was subordinated to an overarching commitment to macroeconomic stability. These resources could in principle come from three sources: (i) Revenue growth derived from the expansion of the economy (ii)Re-allocation of budgetary resources from less priority uses and towards the social sector (iii) Expansion of available revenue mainly through added taxation.

12. The Financing of Social Policies in Chile: A Public Finance Perspective If real social expenditure of the central government Gs (deflated by CPI) is: Gs = Y · δ · α · β Where: Y = real GDP (deflated by CPI) δ = total government expenditure as a percent of GDP α = percent of total expenditure that remains after interest payments β = percent of total expenditure (after interest payments) that is allocated to social programs The percentage growth in real social expenditure can be approximated(ignoring small residual cross terms) as:

13. The Financing of Social Policies in Chile: A Public Finance Perspective Applying the above formulation to the case of Chile, we get the following financing results for 1993-2000:

14. A Simplified Analytical Model for Analysis of Social Policies: A Microeconomic Perspective on the Education Reform and Its Effectiveness Simple model of social welfare maximization: Available civil servants can be allocated to service their work hours only in two (generally complement) social sectors, namely: L (hours in education) or to N (hours in the alternative social services sector.)

15. Graph 1:Gross Benefit Function (Z) The Graph depicts the equilibrium point for a planners maximization of hiring hours-teachers to the public system, given an exogenous wage rate represented by the slope of the straight line drawn (Zo; Lo.) The green curve presented in Graph 1 is the equivalent of the marginal productivity of hours-teachers.

16. Graph 2: Net Benefits Function Graph 2 is a representation of a slightly more complete case, where the red curve shows the Net Benefits for Education System expansion, considering the “externality cost” on provision of Other social expenditures, when civil servants hours can be allocated to any of both sectors. This can also serve as representing the new optimum for the combined solution on two desired social goods, confronting an exogenous W wage rate for hiring.

17. A Simplified Analytical Model for Analysis of Social Policies: A Microeconomic Perspective on the Education Reform and Its Effectiveness We are interested to check the decision making process for a social planner that, represents society by acting in a given welfare State, and wishes to maximize the social welfare function of society, in terms of the optimum provision of education (Ê) and other social goods (ˆP), subject to budgetary conditions (g) and given wage rates (w.) Thus: Z = F ( E ; P ), and accept E= k * L, and g = w * L + P

18. Conclusions: Lessons Learned and Further Research Needed Fiscal Policy choices: Looking back on what has been contributing to the sustainability of high growth in Chile, and judging also the cases for small and medium sized developing countries in Latin America, the Caribbean, Africa and Asia, I clearly think that it is correct to opt for social services connected to human capital formation, as one of the principal public choices for these societies. It is crucially important that the so-called “dividend growth” can be increasingly geared to the public social services sectors (amongst them education) in economies which not only have the task of improving their skills base for equity reasons, but that have to deal with the challenges of globalization, and with a “catch-up” to standards raised by the new world scenario of the economics of knowledge.

19. Conclusions: Lessons Learned and Further Research Needed “As we look at modern budgets, we find substantial inclusion of items that seem to be in the nature of private, rather than public, goods. Why should this be the case? (...) Certain goods, such as education (...) provide personal benefits to the recipient, benefits that are rivals in consumption and not shared by others. In addition, they also generate externalities that the individual beneficiaries overlook. Supply forthcoming in response to private demand will be suboptimal, and a public supplement is in order. This may be provided by subsidizing private purchases or by public provision.” Richard Musgrave (Public Finance and Public Choice, 2000.)

20. Conclusions: Lessons Learned and Further Research Needed The recommendation is to avoid 2 extreme scenarios: 2. The temptation for gradual populism. This one is a scenario where, in a less visible and more complex fashion, the voices and actions of pressure groups inside and outside the government alliance start attracting, convincing for favor many of the technocrats in various sophisticated ways. 1. Sort of “cowboy-band-wagoning” (old movie type) behavior; when technocrats, panicking by the voices for more government spending in social services and others, they tend to replicate the “lonely-cowboy’s syndrome” (become isolated or secluded.)