Chile - Current economic position and prospects (Vol. 1 of 3) : Main report

RESTRICTED Report No. WH-202b This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION CURRENT ECONOMIC POSITION AND PROSPECTS OF CHILE (in three volumes) VOLUME I MAIN REPORT September 10, 1970 South America Department  CURR ECY EQUIVALENTS us$si00 * 9.88 Eacudos 1 Escudo (E) - US$0.101 1 million Escudos US$101,214.7  This report is based on the findings of an Inomi.cissi.o to Chile in November and December 1969.1 In view of the 72iiT~ii presidential elections of September 1970, the report makes no attempt to forecast the behavior of the new Government to emerge from these elections. Rather, it concentrates on an analysis of the development potential of the Chilean economy and on identification of the economic policy issues confronting Chile at this time. Thus, the report recommends a series of policies which the Mission regards as being consistent with the achievement of a satisfactory rate of sustained growth. It is hoped that these recom- mendations may serve as the basis for discussion with the new Government as to the economic policies which, in fact, it will pursue. l2/ The Mission was composed of Messrs. Enrique Lerdau (Chief of Mission), Roger P. Hipskind (Deputy Chief), Carlos Quijano (Economist), Gerhard Thiebach (Economist), Wando Borges (Consultant, Transport Sector), George Perazich (Consultant, Industrial Sector), Walter Wilcox (Consultant, Agricultural Sector), Alphonse Shibusawa (Public Investments) and Ian Hume (Public Investments).  CURRENT ECONOIKIC POSITIOM AND PIDSPECTS OF CHILE TABLE OF CONTENTS Page No. BASIC DATA ........ .............. i-ii SUAI4ARY AND CONCLUSIONS ..................... , . ,., . . i-xi I. THE SOCIAL AND IiNSTITUTIONAL FRAMEWORK . . ............ 1 A. Government .... 1 B. Population, Employment and Wages. 1 C. Social Security System .. . . 4 D. Health ... .. ....... ... ...*.. . . .. 6 E. Education ........... * ,........ 9 F. Organization of the Economy ................ 12 G. Socio-Economic Goals ...................... 16 II. PRODUCTIVE SECTORS ........................,.,,... 18 A. Agriculture . . ..................... 18 B. Manufacturing Industry .................... 30 C. The Mining Sector .... .38 D. The Transport Sector ...................... 49 E. Electric Power ............................ 56 III. PUBLIC INVESTMENTS ................................. 59 A. Agr-culture ,............... . . .... ...,... 61 B. In'Xustry and Petrochemicals ............... 62 C. Electric Power ............................ 63 D. Te'ecormunications .... ................ , ,, 63 E. Petroleum and Kining , , ... .... .. 64 F. Housing and Urbanization ..... 65 G. Health and Education .. . ................. 66  Page No. IV. THE FINANCING OF THE ECONOMY . ...................... 68 A. Availability and Use of National Resources. 68 B. Prices .................................. 71 C. Public Finance ............................ 73 D. Monetary Management ....................... 87 E. The Balance of Payments ....................... 95 STATISTICAL ANNEX ANREX 1 Copper ANNEX 2 Projects for External Financing  BASIC DATA Area: 286,396 sq. miles Population (1969): 9.4 million Rate of Growth 2.0 per annum Gross National Product (1969): US$5.O billion GNP Per Capita (1969): US$490 Gross Fixed Investment as % of GDP (1969): 15.3 National Savings as % of GNP (1969): 16.8 Annual Rate of Growth in GDP: 1964-66/1961-63: 4.9 1967 2.3 1968 2.7 1969 3.5 Output by Sectors, 1969: Agriculture and Fishing 7.4% Mining 10.8% Manufacturing 27.2% Construction 4.3% Electricity, Gas, Water and Sanitation 1.6% Transport and Conmmunications 5.0% Other Services 43.7% Total 100.0% Consolidated Cash Operations of the Central Government (In millions of 1969 Escudos]: Revenues 13,100.0 Current Expenditures 9,211.5 Surplus 3,888.5 Capital Expenditures 3,556.o Overall Surplus 332.5 Financing (net) -332.5 (a) Net External Borrowing (-332.0) (b) Net Internal Borrowing ( 337.0) (c) Cash Balances, Errors, (-337.5) and Omissions  Money, Prices and Exchange Rate: Money Supply Cost of Living Index Exchange Rate Millions Current Percent Percent Change EO/US$ Percent Escudos Change Dec.-Dec. Ehd Year Change 1967 5,381.5 32.1 21.2 5.75 31.9 1968 7,417.3 37.8 27.9 7.58 31.8 1969 10,511.7 41.7 29.3 9.88 30.3 Balance of Payments in Millions of U.S. Dollars (1969): Exports of Goods and Services 1,326.9 Imports of Goods and Services -1,o65.0 Resource Gap (- = inflow) 261.9 Interest Payments (net) -83.1 Other Factor Income -157.8 Current Account Balance 21.0 Official Donations 10.0 Foreign Direct Investments 34.8 Loan Disbursements 306.0 Loan Amortizations -154.4 Other Transactions 2.5 Net Short-term Reserves -219.9 Net IMF Position, Dec. 1969 (- = debt): -57.0 Commodity Concentration: 196h 1969 Copper 66.7% 79.4% Iron Ore 11.4% 5.9% Nitrates and Iodine 5.8% 1.6% Fish Meal 2.7% 1.7% Cellulose and Paper 1.1% 2.0% Other 12.3% 9.4% Foreign Exchange, Reserves of Banking System (Dec. 19 69) : Gross US$485.6 million Net US$3h1.3 million External Public Debt (Dec. 1969): US$2,196.0 million External Public Debt Service Ratio, 1969: 184%  ZDrVI' Y AND CCNCL`s:`-c--I 1. Since its inception in 1965, the present Government of Chile has pursued a set of ambitious socio-economic goals which may be summarized as follows: (a) redistribution of income in favor of labor and increased participation of labor in economic decision-making through greater unionization of the labor force, agrarian reform, etc.; (b) achievement of adequate rates of economic growth through: (i) improvement of the internal terms of trade of agriculture; (ii) stimulation of certain "dynamic" industries; and (iii) raising the national propensity to save through appropriate fiscal and financial policies; (c) modification of the structure of Chile's chronically unstable balance of payments through expansion of copper output, increased Chilean participation in and control of copper earnings, and other measures; and (d) gradual stabilization of the internal price level. 2. On balance, Chile's performance in pursuing these goals has been impressive, even when due account is taken of the role which external factors - large net inflows of external financial assistance and the recent spectacular upturn in world copper prices - have played in the result. But serious problems related to certain basic traits of Chilean society remain which pose some threat to the future development of the country. Among these problems, the gradual acceleration of the pace of inflation since 1967, the climate of inadequate price incentives and uncertain institutional horizon confronting agricultural producers, the inefficient organization of the industrial sector, and the extent to which the market mechanism is prevented from exercising its resources allocating function figure prominently. 3. Despite a favorable turnaround in the mid-sixties in the balance of its goods and non-factor services account resulting from the beginning of the copper price upturn, advances in non-copper exports, and import controls Chile has depended upon large gross capital inflows. This was the result not only of its heavy debt service burde; estimated at 21.5 percent in 1970 but also of the income remitted to foreign owners of its principal copper mines. Even before assuming office, the Frei Government commenced discussions with the copper companies with a view to improving the structure of the balance of payments by approximately doubling copper output and increasing Chilean participation in and con- trol over copper revenues. As a result of these discussions the copper companies in 1967 agreed to participate in a program to expand copper production and refining facilities which would increase the volume of copper output from 1,290 to 2,425 million pounds annually and the propor- tion of output locally refined from about 50 to 80 percent by 1972.  - ii - Implementation of this program is on schedule and the first substantial increment in output is anticipated in 1970. In 1967 the companies also agreed to Chile's purchase on 18 year terms of 51 percent of the country's second largest mine and its minority participation in two new large mines to be opened in the context of the expansion program. At that point, however, world copper prices had increased from the US$0.30/lb. level characteristic of the early sixties, to US$0.50/lb. Subsequently, the rate of copper price increase accelerated so that, by 1969, copper prices averaged US$0.66/lb. 4. With this acceleration, the Chilean authorities concluded that the participation in copper earnings provided by the 1967 ownership arrangements and at tax levels guaranteed in that year was clearly in- adequate. Consequently, they imposed a progressively increasing over- price tax on profits accruing to foreign equity holders from prices in excess of US$0.40/lb. and negotiated the purchase of 51 percent of the equity in the country's first and third largest mines from the Anaconda Corporation. Payments on this purchase are to be made over a 12-year period ending in 1982 and the Government is obliged to purchase the remaining 49 percent by December 31, 1982, also on 12-year terms. Actually the Government has the option of purchasing the remaining 49 percent as early as January 1, 1973 on condition that it accelerate its payments on the original purchase. It is anticipated that this option will be taken up as of the beginning of 1973 owing to the large dividends otherwise payable to Anaconda at foreseeable copper prices. 5. During the Frei administration, Chile has gradually but steadily improved its foreign reserve position from a negative level to the equi- valent of 1.5 months' imports by December 1968. Then the US$0.66/lb. average 1969 copper price yielded a surplus of approximately US$220 million in the balance of payments during that year; bringing Chile's net reserves to a level equal to approximately 3.8 months imports. Although copper prices can be expected to decline somewhat from the 1969 leval - this report projects US$0.55/lb. as a new plateau price aft. r 19'O - greatly expanded copper output together with new taxation and ownership arrange- ments can be expected to yield a 32 percent increase in net export earnings over 1969 levels by 1972. Over the 1970-75 period Chile will have improved its net foreign exchange earnings by some US$1.6 billion as the result of its program to expand copper production and increase its participation in copper earnings. Thus, as opposed to improvements to date which have largely been a function of copper prices and external assistance, Chile has succeeded in dramatically strengthening its balance of payments out- look through its own efforts. 6. Chile's success in redistributing income through its fiscal policies has been almost as impressive as has action to improve the balance of payments posture by increasing net copper earnings. Central Government revenues have increased from the equivalent of 15.4 to the equivalent of 21.4 percent of GDP over the 1964-69 period. A substantial part of this improvement is attributable to higher copper revenues but increases in sales tax rates and improvements in tax administration have  - iii - also been very significant. Miuch of the increase in revenues has been used to finance higher public sector wages and thus directly redistribute income; civil servants' wages are estimated to have increased about 100 percent in real terms from 1964 to 1969. Public sector savings have also increased, however, from 5.9 to 10.1 percent of GDP and, while public investment was 58 percent greater in real terms in 1969 than in 1964, the portion of it financed from public savings was 81 percent in the latter year compared to 60 percent in 1964. 7. The composition of this increasing public investment reflects the Government's effort to redistribute income through its spending policies. Housing has been the biggest claimant of public sector invest- ment resources, averaging some 23 percent of the total since 1964. Hew housing starts financed by the Government have averaged 45,000 annually, including those in the form of urbanized sites with dwelling shells distributed by the Government for completion by their new owners. Al- though the housing program may have been inefficiently administered and, prior to the introduction in 1967 of the self-built housing program, may have failed to reach the lowest income groups, it has had a beneficial employment effect and is visibly improving the living conditions of the two-thirds of Chile's population now residing in urban centers. Invest- ments in other social infrastructure (urbanization, education and health) have accounted for 1L4 percent of public investment during the 1964-69 period while economic infrastructure (fuel and power, conmunications and transport) have taken some 30 percent. Reflecting the priorities attached by the Government to agrarian reform, the copper program and the devel- opment of certain dynamic industries, such as petrochemicals, steel, pulp and paper and food products, investments in the directly productive sectors have increased from 25 percent of the total in the 1964-66 period to 30 percent in the 1967-69 period. This includes--inter alia--amounts in- vested in compensation of expropriated land holdings and in the purchase of copper equity. It also includes public savings repassed as credit to private investors by various official intermediaries. At least in the case of agrarian reform, however, even public investment in the directly productive sectors may be said to have had a redistributional effect. 8. The conflict between the goals of income redistribution and gradual achievement of price stability has been the principal cause of perhaps the most serious shortfall from the Government's original objectives, having resulted in an acceleration of inflation since 1967. The Government did succeed in reducing the rate of inflation as measured by December to December changes in the cost of living index from approximately 50 percent annually in the 1963-64 period to 17 percent in 1966 while simultaneously increasing real wages in amounts ranging from 10 to 40 percent in the case of various wage categories for which indexes are available. Augmenta- tion of the bargaining power of labor through substantial expansion of labor organization, including that of rural labor, together with adminis- tered wage adjustments (minimum wages and Government salaries) more than proportionate with intervening living cost increases were made consistent with declining inflation by tax, monetary and price control policies which reduced profit margins. After 1966, however, wheni profit margins were  - iv - no longer readily susceptible to reduction and little unused production capacity seemed to remain, the Government found itself unable to exercise effective control over wage demands and inflation reaccelerated, from 21 percent in 1967 to about 30 percent in 1969. 9. As fiscal and monetary policies continued to restrain demand, changes in the price level were essentially attributable to increasing costs and only subsequently ratified by expansion of the money supply. Except for the legal minima, wages have continued to increase in real terms, such increases ranging from 16 to 47 percent in various sectors as between 1966 and 1969. In 1970 the Government will do well to hold inflation to a level of 30 to 35 percent; wage adjustments already con- ceded range between 30 and 40 percent. 10. Redistributional and development policies have been especially difficult to reconcile in the case of agriculture. The Frei Government recognized from the outset that relative stagnation of agricultural out- put was largely attributable to inadequate producers' incentives. Follow- ing some apparent improvement of the terms of trade of agriculture in 1965 and 1966, the Government established as its goal a 5 percent real increase in farmgate prices over those prevailing in 1966 by 1971. Statistics deflating farmgate prices by a composit index of wholesale prices and the cost of living show real farmgate prices in 1969 to be approximately 11 percent above those of 1964. Deflated by an index of input prices, however, farmgate prices are shown to be 13 percent less in real terms in 1969 than in 1964. This is primarily attributable to labor costs which account for some 44 percent of total agricultural inputs and have increased by-a--factor of 4.5 in nominal terms since 1964 as compared to the three.and_a-half fold increase registered by the output price index. 11. Another manifestation of conflicting po2icy objectives adversely affecting agriculture stems from the specially strict control of the retail price of agricultural commodities weighing heavily in the cost of living index. Thus, while farmgate prices of dairy products have increased rapidly relative to other agricultural prices and elicited an increase in supply, processors' margins have been squeezed by retail price controls to the point where bottled milk is in short supply in the urban centers. 12. Although one of the main policy goals of the Frei Government has been agrarian reform, enactment of enabling legislation was delayed two years - until November 1967 - by congressional opposition. For this and for budgetary reasons 26,500 peasant families are expected to have been resettled on expropriated land when the mandate of the present Government terminates in November 1970, as compared to the original goal of 100,000. The legislation provides that land which is abandoned, underutilized or rented may be expropriated. It theoretically limits  individual land holdings to the equivalent of 80 basic (i.e., "irrigated") hectares unless exploited under "optimum" conditions. Until recently most expropriations have been of clearly under-exploited lands and the labor and material inputs which CORA (the agrarian reform agency) and other agencies have concentrated on these plots will probably be shown to have increased their physical productivity. It may be more difficult to show increased productivity on some of the more efficiently managed farms recently expropriated. Agrarian reform may well improve the overall efficiency of Chilean agriculture given the distorted tenure distribution of the past but uncertainty as to the way expropriation authority may be exercised in the future tends to operate as a disincentive to efficient private operators. 13. While 9 percent of cultivated Chilean land was irrigated in 1965, irrigated lands accounted for about 45 percent of total Chilean agricultural output in that year. Despite its crucial importance to the sector, irrigation is notoriously inefficient in Chile; distribution systems are poorly designed and maintained and the utilization of existing facilities is unnecessarily wasteful of water. Although existing legis- lation--including the agrarian reform law--provides authority for the levying of water charges, Chile's 1970 budget projects only the equivalent of US$100,000 in revenues from this source. Government officials agree that water charges would tend to improve the efficiency of irrigation and that water revenues could help finance new irrigation facilities but no effort to actually apply such charges appears to be underway. 14. Value added in Chilean industry has increased at an annual rate of 5.9 percent since 1960, but employment creation in the sector--which presently employs some 19.5 percent of the employed labor force--has averaged only 2.6 percent annually. Reflecting the fact that practically the only local source of investment credit is the Government and that the Government has concentrated its resources in basic metals, paper and pulp, chemicals and food products, these subsectors have grown fairly rapidly in recent years. Some of the more traditional subsectors--such as textiles--have remained stagnant. 15. Analysis of industrial investments sponsored by the State Devel- opment Corporation (CORFO)--the Government's principal intermediary for channeling resources into the productive sectors--shows the average cost of the job formation to be very high, particularly in new enterprises where latitude for choice of factor mix is greatest. Besides lack of discretion as to the choice of alternative technologies, this probably reflects the disproportionate increases in labor costs which have tran- spired since 1964. Such costs not only include wages--as already noted-- but also a variety of social security burdens--i.e., retirement, family allowances, health insurance, the capital cost of recently enacted workers tenure guarantees, etc. Thus, while the Government's redistributional policies may have increased wages in real terms, there is some evidence that they have had adverse employment effects. Although unemployment is offi- cially estimated at about 5.4 percent nation-wide, there are indications that if short work weeks and biases in sampling techniques were taken into account, unemployment would be shown to be much higher.  - vi - 16. Analysis of a sample consisting of 34 of the largest 100 Chi- lean industrial firms publishing balance sheets shows after tax profits as a percentage of either gross sales, total assets or equity, declining since 1966. While there may be doubts as to how general this trend has been, certain financial phenomena are reasonably clear. For the firms in the sample, 26 percent of assets was financed by short-term credit liabilities in 1967. The cost of such credit has risen rapidly in real terms since the mid-sixties as the Government moved to establish positive real interest rates and improve credit allocation by imposing a variable tax at rates ranging up to 50 percent on interest charges. The great dependency of industrial enterprises on short-term financing, in turn reflecting the scarcity of investment credit and the lack of a market for equity capital, has made this rapid increase in financial costs especially onerous. Moreover, establishment of positive real borrower's interest rates has not been accompanied by similar improvement in depositor's interest rates; only a limited volume and variety of savings instruments currently yield positive real returns to the private saver. 17. The major problems in industry are the inefficient vertical organization and excessive proliferation of industrial enterprises. This reflects two factors: (a) the turnover sales tax--the Central Government's chief revenue earner--which has a cascade or pyramid effect; and (b) excessive levels of protection against external com- petition. 18. Chile presently has an elaborate structure of import restraints, including: ad valorem and specific duties; prior deposits and delayed delivery of import cover which impose interest costs on importers; and a system of absolute restraints featuring a list of permitted imports and a series of prohibitive 10,000 percent prior deposits incident on certain items included on the permitted list. Chile has important reasons for relaxing these barriers: (a) improvement of the competitiveness of local industry through exposure to foreign competition and reduction of the import tax burden on imports of intermediate goods not produced in Chile, now especially important in order to prepare such industry for Chile's participation in the Andean Common Market; and (b) alleviation of the pressure on the price level which would otherwise result from the impact of a large increase in export earnings on a relatively constant supply of goods and services. In recognition of these factors, the authorities, undertook a program to liberalize imports. A number of items produced in Chile, primarily of the consumer goods and variety, were added to the list of permitted imports in December 1969. This is expected to increase the import bill by about US$40 million in 1970 and be primarily useful in terms of easing price pressures. During 1970 and subsequently, however, many additional items were to be added to the list and various modifications to be made in the tariff schedule with a view to establishing reasonable levels of protection and reducing costs. Also, the process of gradual reduction of the foreign exchange delivery period and elimination of the prior deposits was to be continued.  - vii - 19. This strategy involves a shlift in emphasis from import substitu- tion to export promotion. Although the allocation of scarce internal investment resources has been largely concentrated in import substituting activities such as steel, food products and chernicals, more recently it has also promoted various export industries such as pulp and paper. In the future, internal investment resources are expected to be increasingly allocated to export producing industries including fruit, other foods and forestry products for the general market and vehicle parts and other metal products for the Andean market. Chile's "non-traditional" exports (i.e., all those save copper, nitrate, iron ore and copper mining by- products) have been increasing at an average annual rate of about 9 per- cent as Chile has marginally reduced the over-valuation of its exchange rate in recent years through consistent bi-monthly adjustments somewhat more than proportionate with internal price increases. Continuing over- valuation--if employment is taken as a criteria, rather than balance of payments results only--is evidenced by a system of drawback subsidizing non-copper exports at a weighted average rate of about 30 percent, however. Continuing exchange rate flexibility will thus be required. 20. Chile's real gross domestic product has grown at an annual aver- age rate of 4.5 percent during the "sixties" but at only 2.9 percent annually since 1966. Slower growth in the last three years has been to a certain extent the result of drought which adversely affected agri- cultural, industrial and mining output. Increases in per capita income have been significant as the rate of demographic growth has declined from an estimated 2.3 to 2.0 percent in recent years. This reflects not only the relatively advanced educational attainments of the society (about 85 percent of the population over 15 years of age is literate) but also the operations since 1965 of an "abortion control" program whereby about 7 percent of the female population of child bearing age is presently systematically equipped with birth control devices and maintained under voluntary observation. Based on the impact on fertility rates of con- tinuation of this program in slightly expanded magnitude the population division of the U.S. Census Bureau has projected an average annual demo- graphic growth rate of 1.8 percent during the 1970-75 period for Chile. 21. Domestic savings have ranged widely between 13.1 and 19.5 per- cent of GDP over the 1960-69 period. During the 1960-64 period when external resources flowed into the country at an average annual rate equal to the equivalent of 2.8 percent of GDP, investment averaged 17.4 per- cent of GDP. Subsequently, as resources moved increasingly in the opposite direction owing to surpluses in the goods and non-factor services account investment declined somewhat to an average level equal to 16.6 percent of GDP. The drain on domestic savings became especially acute in 1969 when high copper prices increased the negative resource gap to the equivalent of 3.6 percent of GDP. As indicated above, very large factor payments, averaging 3 percent of GDP throughout the 1960-69 period, together with the build-up since 1964 in Chile's net foreign exchange reserves, have required large net inflows of external capital despite the turnaround in the resources gap. Another prominent characteristic of Chilean national  - viii - resource availability and use is the extent to which investment has been increasingly and predominantly financed by public sector savings, either in the form of direct public sector investments or of the repassing of resources to private investors by official intermediaries. Public savings is estimated to have averaged 51 percent of total domestic savings over the 1967-69 period as compared to 36 percent during 1964-66. 22. Throughout the 1970-75 period, GDP is expected to grow at an annual average rate slightly in excess of 6 percent. During 1970-72 such growth will be largely the result of fruition of investment programs under- taken prior to the projection period, especially in copper, as well as of recovery from the drought. Subsequently, higher investment levels than have been characteristic of the recent past are projected to be required as the industrial sector takes the leading role in the growth process, expanding at an annual rate of 7 percent, and agriculture follows a steady growth path of 4 percent. The domestic savings required to achieve this projection would average 18.8 percent of GDP in the 1970-72 period and 19.8 percent in 1973-75 as the marginal savings rate increases from 19.6 percent in 1967-69 to 24.2 percent in 1973-75. One check on the viability of this program is the extent to which it would permit con- sumption to increase in real terms. This is especially important in view of the redistributional process set in motion by the Frei Government and the difficulties it has encountered in capturing voluntary savings in the private sector. According to the projection, real consumption would in- crease at an average annual rate of 5.2 percent during the 1970-75 period or by 3.4 percent annually on a per capita basis. 23. Public sector investments are projected by this report to grow at an annual average real rate of 4.4 percent during the 1970-75 period as compared to 10.2 percent during the 1965-69 period. This is provi- sional and on the low side; reflecting the impending change of Government and the non-existence of any comprehensive long-term development plan, there is no official sector investment program. Instead, the public in- vestment projection is based on the tentative plans of individual investing agencies and some broad normative judgments as to appropriate levels of investment activity in certain sectors such as housing. The composition of public investment is expected to shift: that in the directly productive sectors averaging 38.3 percent of the total as compared to 27.5 percent in the past as resources are increasingly channeled through intermediaries and the agrarian reform program continues to absorb large amounts of capital; that in social infrastructure declining to 28.5 percent in 1970-75 as com- pared to 36.7 percent in 1964-69 as housing investment grows less rapidly than before but is more efficiently administered; and that in economic infrastructure averaging 25.3 percent of the total as compared to 30.4 percent in the past. 24. Taking into account the large volume of copper revenues wJhich will accrue to the public sector as well as the external financing implicit in the project list annexed to this report, substantial cash surpluses are shown to be accumulated after the capital outlays projected above. In  - ix - view of the lack of investment credit which Chilean commodity producers have suffered, it is assumed that rather than utilize these surpluses for additional direct investments, the Government will transfer them to the commodity producing sectorsthrough its official intermediaries, through the banking system or perhaps even by reducing taxes and its role in resource allocation. Thus, while public savings are projected to con- tinue to constitute about half of domestic savings, Government direct investment is shown to decline from 54 percent of total fixed capital formation in 1969 to 42 percent in 1975. 25. Mlerchandise exports are expected to grow at the annual rate of 9.2 percent during the 1970-72 period as the copper expansion program yields large increases in output each year during this period. By 1972, copper will account for 79 percent of total goods exports. Even this modest total export growth path assumes a steady 13 percent average annual increase in non-traditional exports, clearly demonstrating Chile's need for export diversification. In line with liberalization, merchandise imports are shown to increase at an annual rate of 9.8 percent during the 1970-75 period, reaching the equivalent of 17.8 percent of GDP in 1975 as compared to 14.6 percent on average during the 1960-69. Reflecting suggested reductions in tariffs on intermediate goods, intermediate goods imports are expected to account for the bulk of the absolute increase in imports over the 1970-75 period. 26. In 1970 the ratio of service in Chile's public and publicly guaranteed debt to export earnings net of large mining company remittances is expected to be 21.5 percent. This ratio is expected to peak at 25.5 percent in 1972 as Chile makes a large special payment to Anaconda enabling it to take over the remaining 49 percent of the country's first and third largest copper mines in 1973. Reflecting lower copper profits remittances and reduced service on equity debt contracted in connection with copper nationalization, the 1975 debt service ratio is shown to be 21.6 percent. Net foreign reserves will continue to accumulate through 1973, peaking that year at the equivalent of six months' imports. Thereafter, Chile is assumed to take on new external debt in sufficient magnitude to keep reserves from declining below the equivalent of four months' imports. A long-range forecast assuming that this reserve level is maintained, that the term and interest structure of new debt is similar to that of the recent past and that both exports and imports increase at annual rates of 6 percent shows the debt service ratio gradually declining through 1985, the terminal year of the forecast. 27. Annual gross inflows of public and publicly guaranteed loans throughout the 1970-75 period are projected to be about equal to those of the late "sixties" at about US$300 million. New commitments of public and publicly guaranteed debt required during the 1970-75 period to yield these gross inflows total approximately US$1.6 billion. Of this total, about US$1.2 billion is associated with the public investment program while the balance is expected to be obtained in the form of guaranteed credits to the private sector.  28. The development prospects of Chile have improved with the easing of its balance of payments constraints. Exploitation of this new potential will be contingent upon Government policy at the sectoral and macro-eco- nomic levels. A number of critical issues are identified in this report. In the transport sector, the major issue is one of coordinating investments in and operations of competing modes of transport, especially in certain regions such as the Santiago-San Antonio-Valparaiso triangle and with re- gard to specific operational aspects such as the appropriate reconciliation of highway user charges and railway freight tariffs. 29. In the agricultural sector, the major issues have to do with inadequate producers incentives, the uncertain institutional framework and inappropriate factor pricing, especially in the case of water. In the industrial sector, more efficient distribution of investment re- sources, employment of more labor intensive technology, modification of the sales tax and replacement of the direct price control mechanism by indirect restraints such as those stemming from import liberalization is required. 30. On the macro-economic level, the Government will have to be more effective in reconciling conflicting policy goals, especially by exercising some restraint on wage demands and in improving incentives for private sector savings. Also, the Government is now faced with the need to liberalize imports expeditiously and selectively if price pressures are not to mount, the newly expanded resources base to be productively utilized and Chilean industry to be made reasonably competitive. Finally, policies which recently have been successfully pursued--such as the flexible exchange rate policy, the policy of avoiding recourse by the Treasury to deficit financing by the monetary authorities and the policy of controlling the contracting of external indebtedness in order to avoid deterioration in its term structure--will have to be continued. This last is especially important since considerable discipline in the contracting of new external obligations will have to be exercised if Chile's debt service ratio is not to increase appreciably. 31. Although the Government had already embarked upon import liberal- ization, the reaction of importers to the liberalizing measures it will take and the structural and growth effects of higher levels of imports have yet to be demonstrated. iMoreover, in addition to confronting these un- certainties, pursuit of the import liberalization strategy would require the Government to forego rapid reduction in its debt service burden and/or additional reserves accumulation which it could otherwise achieve. Ef- fective import liberalization merits strong support by official lending agencies. Based on their own tentative lending program, such lenders would cover about 43 percent of the new external financing required by Chile during the 1970-75 period at projected import levels. The cost of more rapid growth in terms of the debt service burden could be reduced if this percentage were increased and Chile required to rely less heavily on commercial credits. Concerted and flexible response by the lenders and the Government to the impact of import liberalization on the Chilean economy could thus greatly facilitate the execution of Chile's new devel- opment strategy.  - xi - 32. Largely as the result of the achievements of the Frei Gov- ernment, therefore, Chile appears to be in a position to overcome the resource restraints which obstructed its development in the past. Whether Chile now actually will enter into a period of sustained and fairly rapid growth depends on successful resolution of the policy issues defined in this report.  I. THE SOCIAL LAD I;NSTITUTIOMAL FMRAqORX A. Government 1. Chile enjoys a democratic system of Government under a Consti- tution promulgated in 1925. Whith the exception of a brief interlude in the early "thirties" all subsequent changes in Government have been in accord with the procedures established in this Constitution. 2. The Executive Branch of the National Government is headed by a President elected for a six-year term. If no presidential candidate receives an absolute majority, selection of the President devolves upon the Congress wihich chooses between the first and second place candidates. WgTith the Chilean electorate divided among a large number of political parties over a broad political spectrum,three of the last four presiden- tial elections have been decided by Congress which, in each of these instances,has overwhelmingly supported the candidate with the largest number of popular votes. Present President, Eduardo Frei MIontalvo, however, did receive an absolute majority of the popular vote in the election of September 4, 1964. He will be succeeded in November 1970 by the winner of the elections scheduled for September of the same year. 3. The Chilean electorate is constituted of all citizens, 21 years of age or older who are literate. Since the country now enjoys an 85 percent literacy rate among those 15 years of age or older, this limitation has little significance. In any event a recently approved constitutional amendment will eliminate the literacy requirement and lower the voting age to 18. In Chile, eligible electors are obliged by law to vote. Thus voter participation has averaged in excess of 75 per- cent in all elections (presidential, congressional and municipal) since the presidential election of 1938. B. Population, Employment and Wages 4. Chile's population is currently estimated at between 9.6 and 9.4 million persons. The variation in these estimates stems from differing analyses as to what has happened to fertility rates subsequent to the last general Chilean census which was taken in 1960. One of the most careful population projections is that prepared by the Bureau of the Census of the United States. This projection shows the fertility rate to have declined by 17 percent from 1961 to 1967 and assumes that the rate will continue to decline by an additional 18 percentage points between 1967 and 1976 and remain constant thereafter. The basic reason for projecting this decline in the fertility rate is Chile's "abortion control" program (see below, para. 20).1 i/ This projection corresponds to the medium variant in a three series projection.  5. According to this projection, Chile's rate of demographic growth which averaged 2 percent annually during the 1965-70 period, can be expected to decline to an average level of 1.8 percent during the 1970-75 period as the birth rate declines gradually from about 3 to 2.5 percent. After 1975, with fertility remaining constant, the rate of demographic growth may increase slightly as the death rate continues to decline. Reflecting earlier declines in infant mortality and increases in life expectancy, the rate of growth of ChileTs population of working age persons is expected to increase from an annual average level of 2.6 percent during the 1965-70 period to 2.7 percent during the 1970-75 period before declining to 2.4 percent during the 1975-80 period. 6. In 1969, Chile's economically active population was estimated at 3.1 million persons of which about 5.4 percent were unemployed. A recent study prepared at the Catholic University of Chile suggests that if estimates of unemployment were broadened to include: (a) individuals who, while not actively seeking employment would accept employment if it were offered them; as well as (b) the unemployment equivalent of short work weeks, total unemployment would be shown to be about four times as large as the 5.4 percent figure. WIith about 80,000 net new additions to the labor force, annually, Chile has recently been creating new jobs at the rate of about 70,000 annually. (See Table 1.2 in Statistical Appendix). 7. Two of the Frei administration's major policy goals have been to increase the involvement of labor in economic decision-making and to im- prove the distribution of income. The former was to be accomlplished largely through the process of unionization. Between 1964 and 1968 the proportion of the total labor force incorporated into labor unions was increased from 10.3 to 17.5 percent. Much of this increase has resulted from the unionization of agricultural workers which was promoted by legislation enacted during the Frei Government (Law No. 16625 of April 29, 1967). 8. A key device for redistributing income adopted by the Frei Gov- ernment was a system of wage and salary adjustments thich, at least in the 1965-67 period, was deliberately designed to produce substantial real increments in wage levels each year. This policy was supported by a mechanism of price controls designed to reduce profit margins and, generally, to restrain consumer prices so that gains achieved by workers through the wage adjustment process would not be wiped out by increases in the cost of living. This wage and pricing policy had to be reconciled with other goals such as those of improving the internal terms of trade of the agricultural sector and creating incentives for industrial expansion. Reconciliation has not always been possible.  - 3 - 9. Wage and salary adjustments for unionized workers are negotiated annually in collective bargaining agreements. Wages of Central Government employees and of non-union workers in decentralized Government entities are adjusted annually by legislative provision. For 1969, such provision was made in the budget law but the more normal practice has been to enact a separate wage bill which usually takes effect in April of each year. Remuneration of other workers is broadly related to legal minimum wages. Minimum monthly wages for employees (i.e. white collar workers) are set annually by province. Minimum daily wages for workers (i.e. blue collar workers) are set annually on a nation-wide basis. Formerly, minimum daily wages for agricultural workers were distinguished from and lower than minimum industrial worker wages. This was modified in 1965 when the distinction between the two wage categories was eliminated, the agricul- tural workerst minimum wage being more than proportionately adjusted with that of industrial workers in the process. 10. Since 1965 wages of unionized workers in manufacturing, mining and various public utilities have increased in proportions ranging between 76 and 42 percent in real terms. Miners, by virtue of their strong union and the vulnerability of the copper companies to work stoppages, have received the largest increase. Civil servants in the Central Government and in various decentralized agencies have received real increases of 34 and 23 percent over the period, respectively. On the other hand, minimum wages for employees and workers have increased by only 5.4 and 5.2 percent in real terms, respectively. It should be noted that these figures understate the improvement of agricultural wages in particular owing to the above-mentioned special adjustment in agricultural wages in 1965. Also these figures do not take into consideration improvements in non-wage, social security benefits, and the impact of increasing unioniza- tion of the agricultural labor force on overall wage levels in the sector. INDEX OF REAL WAGES AND SALARIES (1965 = 100) Minimum Wagesv Average Salary Levels by SectorL/ Decen- Manu- Central tralized Year Employees Workers Utilities Mining facturing Government Agencies 1966 1.071 1.069 1.152 1.191 1.160 1.115 1.058 1967 1.118 1.116 1.369 1.499 1.298 1.320 1.176 1968 1.076 1.074 1.490 1.527 1.336 1.274 1.154 1969 1.054 1.052 1.660 1.755 1.415 1.340 1.228 / Minimum wages are adjusted once yearly: In 1965 they were adjusted as of May 1; in 1966 as of April 1; and, in each subsequent year, as of January 1. / Direcci6n de Estadistica data show indexes of average nominal levels quarterly. For purposes of this table the mean of the quarterly averages was taken each year. As in the case of nominal minimum wage values, these nominal salary levels were deflated by indexes representing average annual changes in the Santiago cost of living. Source: 73ervicic de Seguro Social;Direcci6n General de Trabajo; Direcci6n i. Estadistica y Cersos.  - h - U. The contrast between real declines in minimum wage levels in 1968 and 1269 and continuing real increases in wage levels negotiated by labor unions and conceded to civil servants illustrates still another problem of conflicting policy goals confronting the Chilean Government. Inability to restrain the pattern of negotiated wage adjustment once workers had become accustomed to nominal adjustments more than pro- portionate to intervening living cost increases and unionization of the labor force had substantially increased has been perhaps the principal cause of an acceleration of inflation in Chile since 1967. This accel- eration, in turn, has more than offset nominal adjustments in adminis- tratively determined minimum wages since 1967 which were designed originally to be commensurate with continuing deceleration of the inflationary process. 12. Effective January 1, 1970 the Government increased nominal minimum employees'and workers' wages by 29 percent. The 1970 budget law increases civil servants' wages (including family benefits, etc.) by about 29 percent in nominal terms. Special legislation increases the remuneration of military personnel by about 90 percent in 1970; about 140,000 active and retired personnel are directly affected. A unique agreement negotiated with the Chilean labor union confederation provides in principle that wages of non-union iforkers in decentralized Government entities should be adjusted in 1970 proportionately with the cost of living increase registered in 1969 or by 29 percent in nominal terms. The authorities hope that wage adjustments negotiated in 1970 by the various unions Awll be commensurate with their intent to restrain inflation to about 35 percent during the year. C. Social Security System 13. In Chile the state has for many years borne heavy welfare responsibilities which have recently been growing at a rapid pace. Seventy percent of the population is covered by some form of social security protection, including varying combinations of old age, re- tirement (with as little as 10 years service), survivors, unemployment, family allowance, preventive and curative medical and other benefits. The cost of the system is high--over 16 percent of the national income-- and its efficiency is low, as is reflected by the fact that some 13 per- cent of its annual outlays are for administrative expenditures. DMore- over, the system is inordinately complex, consisting as it does of some 30 separate funds (cajas), each with different financing and contribution rules, as well as different benefits. Each fund covers a particular type of worker or employee; e.g. those employed by the merchant marine, banks, newspapers, armed forces, police, municipalities, customs service, etc. However, the five largest funds cover over 94 percent of all working con- tributors (see Table 12.1 in Statistical Appendix).The structure and growth rate of the system relative to Chile's population in recent years wras:  -5 - 1963 1966 Growth (000) 7T o) (00 7 _7 ( at) Population 8,217 100 8,795 100 7.0 Covered by System 5,354 ZTi 6,435 73 20.0 Working Contributors 1,8147 22 2,030 23 9.9 Non-working Contributors 357 4 505 6 41.5 Dependents 3,150 38 3,900 44 23.8 Source: Superintendencia de Seguridad Social. 14. Until 1966, the last year for which complete data on the operation of all of the funds are available, the system as a whole generated surpluses on current account, which were mainly invested in housing (through mortgage loans and transfers to OORVI, a Government housing agency) as well as in personal loans. The fact that the Central Government was called upon never- theless to increase its transfers to the system may be explained mainly by the non-transferability of resources between individual funds. The Gov- ernment itself makes far lower statutory contributions as an employer than does the private sector (4 percent of payrolls as against 12 percent for most private sector firms) despite the fact that there is relatively little variation between benefits enjoyed by civil servants and those enjoyed by other employees. The problem of non-transferability of social security funds was somewhat alleviated in 1968, when by new legislation (Law No. 16840) the Government provided for a pooling of the various funds administered by the Social Security Service, by far the largest of Chile's many social security agencies. 15. Current account surplus generated by the system in recent years, together with investment by the system in housing through the inter- mediation of OORVI, have been: 1959 1963 1964 1965 1966 1967 1968 (EO million, current prices) Current Revenues 482.2 1,085.3 1,675.0 2,622.3 3,629.6 n.a. 6,500.0 Current Expenditures 413.6 933.3 1,410.7 2,272.5 3,143.8 n.a. n.a. Surplus 68.6 152.0 264.3 349.8 485.8 n.a. n.a. Transfers to CORVI 58.8 114.9 182.9 313.6 361.8 Source: Superintendencia de Seguridad Social.  - 6 - 16. A detailed breakdown of the expenditures of the system by type of benefit and beneficiary, as well as of revenues, by contributor and category of funds is available for 1965 (see Tables 10.2 and 10.3, Statistical Appendix). One striking feature of these figures is that about 59 percent of the income of the funds for public employees comes from direct Government transfers while only 11 percent is paid by the public sector in employer contributions. The beneficiaries, on the other hand, contribute in the following proportions to the total revenues of their respective funds: Workers 12% Private Employees 25% Public Employees 28% 17. The principal deficiencies of the social security system are: (a) the method of adjustment of annuity values which permits them to be increased in nominal terms more than proportionately with wages and salaries, thereby creating an intrinsic financial imbalance; (b) the excessive liberality of time in service criteria for pension eligibility, also contributing to the financial instability of the system; and (c) the proliferation of funds and variation in benefits which not only leads to excessive administrative costs but also creates inequities as between various categories of beneficiaries, especially in relation to the relative amounts of their contributions. In 1968, the Frei Government submitted legislation reforming the social security system to the national congress. The reform would have limited annuity adjustments to amounts proportionate with annual living cost increases, have established minimum age criteria for pension eligibility of principal beneficiaries and otherwise have unified and made more efficient the administration of the system. The legislation changing the method of annuity adjustment was rejected by Congress and the other elements of the reform have not yet been approved. D. Health 18. The provision of health services in Chile is among the most developed in Latin America. It is concentrated in the Servicio Nacional de Salud (SNS) which operates hospitals containing about 90 percent of the nation's hospital beds and employs 70 percent of the nation's physicians. SNS is charged with providing: (a) preventive and curative medical services on a reimbursable basis to the workers covered by the Servicio de Seguro Social; (b) free preventive and curative services to indigent workers (i.e. workers primarily from the agricultural sector, not covered by any social security fund); (c) maternal and infant health care; (d) standard public health services, as in the fields of endemic disease control and pure food and drug administration; and, finally (e) curative medical services on a reimbursable basis to employees (i.e. white collar workers) either covered by or affiliated with the Servicio Medico Nacional de los Empleados (SERNENA). About 30 percent of all SNS patients are workers covered by the Servicio de Seguro Social, another 35 percent are indigents and most of the balance are SER14ENA covered or affiliated employees.  - 7 - 19. The relationship of SNS to SERMENA is a new one, resulting from the Law of Curative Medicine (No. 16781) enacted in May 1968 and implemented in March 1969. The law extends the curative medical insurance formerly provided by SERMENA to public sector employees only to all employees covered by any social security fund. Under this system SEREMNA pays 75 percent of the costs of medical care for eligible employees earning as much as two times the prevailing minimum employees wage, and 50 percent of the costs of such care for eligible employees earning more than two times the minimum wage. SERMENA emits checks in behalf of beneficiaries in amounts determined on the basis of standardized medical fees. The beneficiary is then free to obtain respective medical services from the physician or hospital of his choice. Both by virtue of the share of over- all medical facilities which it controls and of the limits on amounts of individual medical fees for which SERMENA will provide reimbursement the bulk of the care made available under the new scheme is provided by the SNS. In addition to the share of the cost of this care financed directly by the beneficiary, financing for the new system is provided by contrib- utions from respective social security funds and from eligible employees to SERMENA, each equal to one percent of eligible employees' salaries. 20. In connection with its responsibility for maternal and infant care, the SNS maintains the Abortion Control Program mentioned above. High abortion rates--compared to about 250,000 births annually, about 50,000 hospitalized abortions were being recorded each year in Chile-- provided the justification for undertaking this program in 1965. 150,000 women are now provided with birth control devices and kept under con- tinuing observation wfithin the context of the program. This represents about 7 percent of Chile's population of about 2,140,000 women of child bearing age. SNS aims to increase the number of women it equips with birth control devices to the equivalent of about 10 percent of the child- bearing population. The Abortion Control Program has been criticized by some as excessively concentrating available birth control services in a framework which requires subjection to examination and observation by physicians. This criticism is relevant to the extent that women--particu- larly in the lower income groups--would be prevented because of ignorance or poverty from practicing birth control by virtue of their unwillingness to submit to these aspects of the program. On the other hand, there appears to be nothing in the nature of Chilean society which would obstruct either general awareness as to methods of birth control or the availability of birth control devices from commercial outlets. In fact, the general goal of limiting the scope of the program to 10 percent of the female population of child-bearing age presumes widespread recourse to privately- purchased contraception. 21. Public hospital construction and maintenance in Chile is the responsibility of the Sociedad Constructora de Establecimientos Hospita- larios. This agency was created in 1945 and was originally expected to finance most of its construction activity by the sale of the shares to the public. In fact, however, the Central Goverrawient provides the bulk of the Sociedad's capital, in the form of transfer of revenues, some of which are earmarked (i.e. the proceeds of a special tax on iron ore exports  - 8 - are earmarked for the Sociedad) and some of which originate in the general budget. In return from these transfers the Sociedad emits shares on behalf of the Government. Sociedad-constructed medical facilities are rented to the Government to be used by the SNS on a non-reimbursable basis. These rentals are more than sufficient to cover the operating costs of the Sociedad. Sociedad's responsibility does not include provision of hospital equipment. Rather it is the SNS which is responsible for such procurement. HEALTH AGENCY FINANCES (millions 1969 Eo) Sociedad SNS SERMENA Constructora 1966 1969 1966 1969 196W19 Current Revenues 382.1 559.3 129.9 404.9 4.5 4.7 Operating Expenditures 1,322.9 1,493.4 119.5 287.6 6.1 4.6 Investment 43.5 35.5 5.2 10.0 73.6 102.5 Surplus (+) or Deficit (-) -984.3 -969.6 5.2 107.3 -75.2 -102.4 Financing 984.3 969.6 -5.2 -107.3 -75.2 102.4 Current TransfersJ 934.8 935.5 TB 7 10.5 _ _ Capithr Transfers3 36.9 35.0 - - 54.5 34.0 Other3 12.6 -0.9 -23.2 -117.3 20.7 68.4 g/ From the Central Government. y/ From the Central Government and including the transfer of earmarked revenues to the Sociedad Constructora. / Entries in this line represent a composite of inter-sectorial transfers, statistical discrepancies and accumulation of cash balances. Source: Ministry of Finance; IBRD staff estimates. 22. As is evident from the above table, total public sector expend- itures on health have been rising rapidly in recent years. In real terms, current expenditures for medical care increased by 22.4 percent frcm 1966 to 1969 while investments in health facilities increased by 21 percent. Much of this increase reflects the implementation of the above-mentioned Law of Curative Medicine early in 1969. Responsibility for the overall management and planning of public sector health activities in Chile rests in the Ministry of Health. The Ministry has a rather small staff, con- sisting of 15 professionals as compared to the 55,000 member staff of SNS alone. 23. Substantial improvement of the services provided and reduction of their cost could be obtained in the future from more efficient personnel management, improvement in the ratio of out to in-patient care (about 70 percent of medical care provided by the SNS is of in-patients), better health statistics, and overall health sector planning. Especially useful  - 9 - would be a survey of future demand for health services which would take account of population growth, changes in the composition of the population, changes in average educational attainments, increases in per capita income, etc. 24. Despite the imperfections in the system, Chile has made sub- stantial progress in recent years in improving the health of its population: HEALTH INDICATORS, 196b-68 CHILE Indicator 1964 196b General Mlortality Rate / 11.1 9.1 Infant Mortality RateJ/ 105.2 90.2 Infectious Disease Mortality Rate3 60.0 25.1 Diphtheria Mortality Rate!/ 2.6 o.6 N1hooping Cough Mortality RateJ 3.5 0.8 Poliomyelitis Mortality Rate / 0.8 0.2 Measles Mortality RateJ 38.6 12.5 Typhoid Fever Mortality Rate3 2.1 1.4 Tuberculosis Mortality Rate