CHILE INITIAL CONDITIONS, Years Military Rule. 17 Years Military Rule. Over Heated Economy Over Heated Economy –Rate of Inflation 30% –Annualized Import Growth 30% 40 % of Population Below Poverty Line. 40 % of Population Below Poverty Line. General Perception of Unfairness, Too Much Inequality General Perception of Unfairness, Too Much Inequality Private Sector Private Sector –Fear of Populism –Low Confidence and Expectations on New Economic Team.

A NEW APPROACH: GROWTH WITH EQUITY Break Populist Cycle of Center Left Governments. Break Populist Cycle of Center Left Governments. Commitment to Budget Surplus. Commitment to Budget Surplus. Pre-Pay Public Debt. Pre-Pay Public Debt. Tax Reform & the Fight Against Poverty Tax Reform & the Fight Against Poverty Labor Legislation Reform. Labor Legislation Reform. Tripartite Agreements. Tripartite Agreements. External Tariffs Reduction and Open Regionalism. External Tariffs Reduction and Open Regionalism. Deepening the Capital Market. Deepening the Capital Market.

Table 1 Chile´s Economic Perfomance  Annual Rate of Growth 7.8  Domestic Saving Over Gdp22.0  B of P Deficit in Current Acc. 2.5  Total Investment Over GDP (real)27.8  Productivity Increase per year 4.1  Real wage Increase, per year 4.6  Employment, annual rate of growth 3.5  Government Savings over GDP 4.3  Budget Surplus over GDP 1.7 Source: Banco Central de Chile (2001) “Indicadores Económicos y Sociales de Chile ”.

Table 2 Social Expenditures Government Social Expenditure, (*) 48 Government Social Expenditure, (*) 48 Govt. Expenditures in Public Health (*) 62 Govt. Expenditures in Public Health (*) 62 Govt. Expenditures in Education (*) 24 Govt. Expenditures in Education (*) 24 (*) Accumulated Growth 1990 – 1993 Source:C. Pizarro,et al (1996)”Social and Economic Policies en Chile´s Tradition to Democracy”, a book piblished by UNICEF-CIEPLAN.

Table 3 Trayectory of Main Economic Indicators During the Aylwin Administration Growth Rate Growth Rate  Inflation Rate of Unemployment Rate of Unemployment Poverty Rate, % Poverty Rate, % of Population of Population Extreme Poverty, % Extreme Poverty, % of Population of Population Budget Surplus Budget Surplus Public Debt Over GDP Public Debt Over GDP Source: Banco Central de Chile (2001) “Indicadores Económicos y Sociales de Chile ”.

THE POLITICAL ECONOMY OF REFORM Consensus Politics. Consensus Politics. Ad- Hoc Coalition Building for Each Policy Package. Ad- Hoc Coalition Building for Each Policy Package. Weakening of Opposition to Policies. Weakening of Opposition to Policies.

THREE CASE STUDIES : 1. Deciding When To Spend Political Capital: The Key Reform Upfront First 100 Days : Focus On Most Difficult Key Reform Only. First 100 Days : Focus On Most Difficult Key Reform Only. Tax Increase: Tax Increase: –Solidarity in Economic Policy –Legitimize Economic Model –Continuity and Change: Opportunity for Compromise Tie Tax Increase to Specific Social Expenditures. Tie Tax Increase to Specific Social Expenditures.

RESPONSE TO UNNEXPECTED SHOCKS: The Gulf War and The Price of Oil. Policy Package Increase Domestic Price. Increase Domestic Price. Petroleum Stabilization. Fund. Petroleum Stabilization. Fund. Reduce Government Expenditures. Reduce Government Expenditures. Reduce Military Expenditures: Share Sacrifice. Reduce Military Expenditures: Share Sacrifice. Labor Unions Agreement to Lower Real Wages. Labor Unions Agreement to Lower Real Wages. Lower Interest Rate. Lower Interest Rate. Energy Saving Measures. Energy Saving Measures. Constituents in Favor Financial Markets. Consumers Private Sector Civilian Population Labor Unions Business Private Sector. Environmentalist.

GOOD USE OF CHANGING OPPORTUNITIES: CAPITAL INFLOW AND “ENCAJE” Policy Package Lower External Tariffs Lower External Tariffs Tax Capital Inflows Tax Capital Inflows Open Capital Outflows Open Capital Outflows Fiscal Compensation : Tax on Gasoline Fiscal Compensation : Tax on Gasoline Constituents in Favor Consumers Export Sector Financial Institutions Private Sector, environmentalists Passed in 48 hours.

SUCESS AND FAILURE: CHILE Shock Absorption Capacity: Reaction to Volatility in Capital Flows. Shock Absorption Capacity: Reaction to Volatility in Capital Flows. –Policy Response: Reduce Public Debt Reduce Public Debt Structural Budget Surplus Structural Budget Surplus Flexible Exchange Rate Flexible Exchange Rate Inflation Targetting Inflation Targetting Restriction to Capital Inflows Restriction to Capital Inflows Unilateral Opening to Trade Unilateral Opening to Trade Free Trade Agreements Free Trade Agreements

ROLE OF INSTITUTIONS. Upgrade Quality of Institutions: RULES. Upgrade Quality of Institutions: RULES. »Autonomy Central Bank »Independent, Non- Corrupt Judiciary »Congress: Rules for Government Expenditures Transparency Transparency »Corruption: T.I. Index »Campaign Finance »Civil Service Modernization Conclusion: Modernization of the State Upfront, Within First Generation Of Reforms. Conclusion: Modernization of the State Upfront, Within First Generation Of Reforms.

3º GENERATION REFORMS: INNOVATION CAPACITY World Bank Study: Chile Performance Below Average in Innovation. World Bank Study: Chile Performance Below Average in Innovation. –Firms Doing More of the Same –Underinvestment in Research and Development. –No Technological Adaptation –Venture Capital: No Projects –Industrial Policies Trauma –Dispersion in Government Programs –No Strategic Dialogues –No Clusters

DEVELOPMENT LESSONS Rules of Thumb for Shock Absorption Rules of Thumb for Shock Absorption –Public Savings –Low Public Debt –Budget Surplus –Flexible Exchange Rate –Inflation Targetting –Local & Regional Govt. Expenditures –Budget Rules Sequencing of Reforms Sequencing of Reforms Growth With Equity, Not Just Growth Growth With Equity, Not Just Growth

DEVELOPMENT LESSONS Institutional Change: First Generation Reform Institutional Change: First Generation Reform Crisis: Opportunities for Additional Reforms Crisis: Opportunities for Additional Reforms Invest in Cooperation With the Opposition Invest in Cooperation With the Opposition Art of Packaging Art of Packaging Policy Decisions: ad-hoc coalitions Policy Decisions: ad-hoc coalitions Innovation : How to Achieve Continuous and Endogenous Increases in Productivity. Innovation : How to Achieve Continuous and Endogenous Increases in Productivity.