Considerations on the bank's policy toward Chile

 No, E 77 RESTRICTED 66984 I This ! report is restricted . to use within the Bank INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT CONSIDERATIONS ON THE BANK'S POLICY TOWARD CHILE January 25, 1950 Economic Department Prepared by: Jacques Torfs  CONSlDEBATlm~S ON THEi BaNK'S POLICY TOWARD CHILE 1. Summary Chile, oVd.ng to its great physical resources and abundant human talents, should be able to look forward to a rapid increase in its standard of living and to a lasting solution to its chronic balance of payments prob,... lem. However, the poliCies which the Chilean Government has pursued in stimulating economic development have not always been well designed to pro- duce the optimum structure in the countryls economy. In particular, inade- quate attention seems to have been paid to the necessity for reaching a bet- ter balance between exports and import requirements with the result that the burden of the service on Chile f s foreign debt has reached the maximum. whicb can be safely assumed in the absence of positive steps to improve the balance of payments position. It is therefore s1;lggested that the IBED engage with oaution in making new loans to Chile and concentrate its attention upon those projects which promise to make an immediate contribution to Chile'S repayment capacities. The Chilean authorities should be urged to undertake a thorough review of the goals and instruments of their development policy, and then to take more resolute action to fulfill their stated purposes. In this connec- tion it is believed that the maintenance of constant and intimate contacts between the IBRD and Chile. both here and in Chile, is indispensable if the Bank's efforts to help the country are to be effective. 2. The Bgrden of the Foreitm Debt and the BalanC§ of Pa;yme:g.t s The service of Chilets external debt represented in 1948 more than 9% of its current account receipts in the balance of payments. This propor- tion is higher than that prevailing for any other South American country.  .... 2- This fact alone would not necessarily indicate that Chile \~uld be less able to service its foreign debt in case of a world-wide depression than apy other South American state. In considering the ability and willingness of a countr.y to meet its foreign ob1i~tions in times of stress, account must also be taken of the proportion of capital goods, luxury items and durable goods in its normal imports. If this proportion is high, it is likely that imports can fall very low for a period of time before the level of economic activity or the standard of living of the population is seriously affected. But, unfortunately, this is not the case of Chile, in part because this country has already trimmed do',m its imports to a minimum by eliminating all luxury items, but mainly because Chile seems to have given great emphasis in the last twenty years to industries processing imported raw materials (the output of these industries being substituted for imports of manufactured goods). As a result, a reduction in the volume of bulk imports (paper, chemicals, tex- tiles. agricultural raw materials) provokes an immediate decrease in economic activity which manifests itself in unemployment and wage reductions. Another reason for the relative rigidity of import requirements is that Chile imports substantial quantities of foodstuffs (sugar, wheat, livestock, coffee, cacao, tea) and a reduction in their availability would have grave political conse- quences. Finally, refined petroleum products must also be imported. As ShalOm. in the annexed Table I, if 1948 is taken as a typical year, the imports which could be reduced immediately without affecting the economic activity of the country in the short run (new machines and vehicles) represent only 19% of the total imports of the country. Furthermore, from the point of view of Chile's capacity to weather a world-wide depression, it is si~ificant that 7Cf/o of its export proceeds are derived from only t~~ commodities, copper and nitrates, the demand for  -3- which is particularly susceptible to economic fluctuations. The demand for Chilean copper will be largely determined by the level of economic activity in the United States, and as demonstrated last year only a moderate decline in United States industrial production tends to produce a substantial reduc- tion in copper import requirements. Similarly, in the case of nitrates, since the application of fertilizer can be deferred for a period of time in years of low agricultural incomes, fluctuat ions in demand tend to be larger than changes in the gener~ level of economic activity. Aside from the vulnerability of Chile to large-scale international slumps, the country finds itself under more or le ss chronic difficulties in meeting its external P83ll1ents requirements. As shown in Table I (second column) t "essential lf import requirements might well amount in 1951 to $192 million if no basic improvements are made in the structure of Chilean im- port s. On the other hand, as shown in the annexed Table II, while 1948 net exports receipts from copper, nitrate, iron and other products amounted to $250 million, prospects are that in 1951 this figure will be reduced to $140-$200 million even if allowance is made for the development of SOille new export lines. The cause for the reduction is in major part the reduc- tion in both price and volume of copper and nitrate exports. Prospects for both cOrDrnodities are only fair in the short run, possibly better after 1955.±I As far as the other exports are concerned, some hope can be ex- pressed for the prospects of agricultural and forest products, after the devaluation of the peso has taken full effect. Also f exports of crude oil and manufactured copper m&y alleviate the situation. In order to escape the threatened pressure in it s balance of pay- ments, it is clear that Chile should follow a dynamic policy of export y See IAr. Lipkowitz t study Qn copper prospects.  -4- promotion'.,and import reduction. This policy has been adopted as one of the bases for the actions of the Fomento Corporation. In 1945 already Fomento stated that imports would be reduced through agricultural mechanization, the promotion of forest industries, the building of a steel plant, petroleum development, the creation of a newsprint and paper industry, the reduction of livestock imports, et cetera. A si~3able effort has been made to meet these goals - an increase in exports has resulted from the building of a copper foundry, a copper manufacturing plant, and from the drilling of oil wells. Also, it can be expected that by the end of this year the output of the Concepcion Steel Mill will simultaneously decrease payments and increase receipts in the trade balance. However, results have fallen far short of the announced goals. If the whole of the Fomento plan could have been executed by 1951, the level of imports could have been reduced to $150 million, and exports increased to $155 to $220 million. However, little seems to have been done in the field of forest industries, paper, livestock, coal mine mechanization and irri~tion. It cannot be argued that foreign exchange could not have been ~red the execution of these projects. It may be that Chile simply post- poned these issues while awaiting foreign help and devoted available a~­ change resources to the purchase of other capital equipment of little balance of payments significance. It 'Hould be unfair to condemn Chile I s development policy entirely. It is true that an extensive and needed electrification program has been executed, ~hich represented a heavy burden on the capital formation possi- bilities of the country_ Also, mechanization brought forth distinct im- provements of agricultural production. But neither of these projects seems to have resulted in substantial foreign exchange savings, even thoLgh they  - 5- were perfectly justified on economic grounds. In short, it seems that the development policy gave too great emphasis to projects of mainly internal. interest. 3. Internal Effects Of , Development Policy It is difficult to pass judgment on the effects of the development policy of theOhilean Government on internal conditions. Available and esti- mated figures on national income and capital formation are at best tentative. However, some facts are known. - namely, that what was done caused consider- able inflationary pressures even though taxes were raised to burdensome levels; and secondly, that the condition of the majority of the population (rural population) improved very lit tJ.e. if any. The first feature (infla- tion) may result from the fact that the rate of capital formation in the Chilean economy is too high, or Jl'rhaps inadequately directed. Evidence for the first contention is lacking; preliminary estimates made according to similar techniques for both Chile and Colombia indicate rates of capital. for- " mation which are strikingly similar, as follows: Gross Ca~ital Formation in Per Cent of Net National Product at Factor Cost 1940 1943 1$4 1945 1~46 1~47 Colombia n.a. 9.5 9.7 10.1 13 . .7 11.2 Chile 10.8 9.0 10.4 10.9 13.0 10.8 However, Colombia. compared to Chile, did not by any means suffer from such enormous fiscal. difficulties. It did not have to resort to heavy foreign borrowings, did not increase taxes considerably, and experienced nonetheless a much lower rate of inflation. If these figures can be relied upon,  -6- considerable differences in the structure of savings are indicated which deserve further investigation. As concerns the standard of living of the fanner, it seems that the difficulty is in major part social in nature. Chile, one of the most advanced countries in Latin America, is still at the feudal stage as far as land ownership and tenure is concerned. An opinion which has been repeatedly ex- pressed in Chile is that no amount of mechanization would improve the condi- tion of the agricultural ~borer as long as the problem of income distribu~ tion was not solved. Also, it is reported that a major cause for food scarci- ties has been the unwillingness of the major land owners to utilize the whole of their properties for productive purposes. 4. . Prerequi si tes to an IBRD Intervention in Chile Chile can thus be pictured as a country which very soon will have to restrict the level of its economic activity in order to service its foreign debt unless positive steps are taken to adjust the structure of its balance of paymentsj as a country in which great sacrifices and enormous physical difficulties llave resulted in relatively little improvement in the standard of living of the population, except perhaps in the towns; and as a country where the desire for the spectacular seems to have over-shadowed the need for coping with more immediate problems. Nonetheless, the country has great resources, a will to improve a bad situation, and great human talents. It is believed that the country deserves help, but should not receive it if it is not ready to revise considerably its general philosophy. To start with, investments from the IBRD or from pri- vate enterprise should be directed toward those projects which have been developed by Chile with a view to improving its balance of payments.  - 7- Specifically, these projects would include a petroleum refinery, coal min- ing machinery, experimental stations for seeds and animal feeds and ferti- lizers, forest industries, paper and pulp products. The total investments involved in these fields amount to perhaps $45-$50 million. This would enable the further compression of Chilean imports from a level of $192 to $150 million (see Table I). Secondly, it should be possible to develop investment programs which would result in a complete elimination of live- stock import s t a reduction of agricultural raw material imports. a reduc- tion of processed foodstuffs imports, and also a reduction in the import of chem.i.cals and their substitution by local production. The value of invest- ments required to attain these goals, which could reduce the needed level of imports to $118 million a year, is roughly estimated at $50 million. Hence, at the cost of investments amounting to $100 million, it may be possible to reduce the level of tfessential" imports of Chile by about $70 million per year. Obviously t such a result would greatly en- " hance Chile I s capacity to repay the loans involved. It is hoped that pri- vate equity investment can assume some of the burden. Most of the indicated projects would have the double advantage of solving balance of payments problems, and also of brir~ing definite contributions to the Chilean stan- dard of living if adequate measures are taken to insure an equitable di a- tribution of the fruits of agricultural development. The financing of these projects will involve substantial local expenditures. In many instances it has been reported that the local (peso) funds needed to cover the peso and even the dollar cost of projects such as the pulp mill, forest industries, agricultural mechanization, et cetera, were available. If the Government of Chile accepts the projects described above as high priorities, it should find it possible to finance the  -8- associated local currency expenditures from domestic resources. Any diffi- culties on this score could probably be remedied by reorienting the activi- ties of the Ohilean banking system toward the financing of these priority projects. Among Ohile's domestic resources available for financing local currency expenditures will be the local currency counterpart of goods im- ported. en credit for sale to the public (e.g. agricultural machinery); how- ever, the granting of loans for such goods should be based upon tneir direct contribution to Ohile's development program rather than upon their incidental contribution to the local financing of ot her projects. The investments suggested herein can only cope with the most imme- diate problems. In order to determine what further channels development should take, Chile should proceed to a complete re-examination of its re- sources, of its internal policies, andof the characteristics of its capital formation. The creation of a substantial statistical and planning organiza- tion is needed if Ohile wants to avoid in the future the errors of th0 past. . Furthetmore, the Bank owes it to itself and to Ohile to keep in constant and close touch with the further evolution of the Chilean economy so as to be able to give warning signals when needed. Only the development of intimate contacts between the Bank and the Ohilean authorities, both here and in Chile, can achieve that goal.  Table I CHILE Import Reductions (in million US$) Pattern P01!slble Minimum Pntterh~f·()f I~$ in 1951 • I of Assuming No if Developments if Great Efforts lruports Basic Im- Anticipated b;:{ Were Made to 1m- Pl"ovements Fomento is; 1946 prove Balance in in Import Had Taken Place of Payments 1948 Structure , ; , - I. Petroleum 33.0 33.0 16.0 16.0 Coal and Others 3.0 3·0 0.3 0.3 Metallic Baw Materials 2.2 2.2 2,2 2.2 Textile -- Cloth 15.6 15.6 10.0 10.0 - Others 11.0 11.0 11.0 11.0 Machines and Vehicles (Capi tal Goods) Y 50.0 Maintenance Equipment 15.3 15.3 15.3 15.3 Livestock 16.2 16.2 16.2 Other Agricultural Raw Materials 24.8 24.8 24.8 20.0 SUgar 20.6 20.6 20.6 18.0 Processed Foodstuffs 5.5 5.5 5.5 3.0 steel and Iron 20.7 Other tletallic Manu- factures Newsprint and Paper 5·a 5. 5.4 Other Papers 10.8 10.8 10.8 7.0 Chemicals 28.7 28.7 20.0 15.0 Total 268,3 192.1 152.7 117·8 In %of 1948 Total 100% 71% 56% 44% Y Estimated as a fraction of total imports of machines and vehicles.  Table II CHILE History and Forecast of Export R~ceipts t IJS~ (million pil.) 1948 1949 1950 1951 Actual ., Budget Estimated Estimated Copper (Net) 137.5 105.0 50 - 80 80 50 - (max) (min) (max) (min) 36.0 45.0 (~) 33 ..- 45 Nitrates (Net) (~n)- (min) (max) Iron (Net) 2.3 3.5 3.5 3.5 Others 74.0 74.0 40 - (includes cop- 60 40 - (includes cop- 60 per mfg. 5.0) per mfg. 5.0) Total 227.5 126~5' 188_ 126'5 188. (min' (max 5 (min (max 5 Petroleum 4.0 Steel 6.0 Additional Copper 5.0 Total if steel mill pro- ducts, copper, mfg,t and petroleum are exported 141.5 203.5 (min) (max) Total if additional e~ort industries developed 156.5 218.5 (min) (max) •