ALvaro Garcia,
Senior Advisor

After achieving an average annual growth rate of over 7% during the 1990-98 period, Chile is experiencing its first recession in 15 years.

In the first half of 1999, the economy contracted by 2.9% while unemployment increased from 6.2% in 1998 to 11.4% in September of this year.

Despite the strong economic performance registered during the decade, the current downturn has deeply hurt the Christian Democratic-Socialist Concertación coalition that has governed the country since the return of democracy in 1990. While the Concertación presidential candidate, Socialist and former minister of public works Ricardo Lagos, still maintains a lead in the polls ahead of the December elections, right-wing opposition candidate Joaquin Lavin, has recently gained ground. Lavin, the former mayor of an affluent borough in Santiago, has capitalized on popular discontent with the current economic problems by stressing the need for change.

Alvaro Garcia, who served as minister of economics from 1994 to 1998, currently works as a senior advisor on economic policy for the Lagos campaign. According to most observers, he will play a key role in the cabinet if the Concertación wins the upcoming elections.

Garcia recently visited New York to explain Ricardo Lagos’ economic policy strategy to Wall Street analysts and investors. Later he spoke with Karen Poniachik for LatinFinance magazine:

LatinFinance: Beyond the traditional response regarding the maintenance of fiscal balance and external equilibrium, could you identify specific policy actions in the Lagos strategy for moving the country back to accelerated growth?
Alvaro Garcia: To regain growth, we plan to foster investment in sectors like infrastructure, which are very intensive in employment generation, through a strong program of concessions for roads, ports, airports and water companies. We will also support those medium-and small-size firms that are going through financial difficulties and that today generate 80% of total employment in the country in order to help them start investing again.

LF: What would be the Lagos administration’s macroeconomic targets for its first three years in office?
AG: We want to move as fast as possible to a 7% annual GDP growth with an average inflation of 3%. To do that, we have to maintain investment rates of between 28% and 30% of GDP. We will also allow a 4% current account deficit. Unemployment should move down between 8% and 8.5% by next year and reach 6.5% in 2001. We plan to increase savings between 24% and 26% from the current 22%. To attain this, we will monitor the pension funds in a much stronger way so they keep their payments up to date: About 20% of the people enrolled in private pension funds have their monthly savings discounted from their paychecks by their employers, but do not get the money deposited in their individual fund account.

We are also going to ease the way in which self-employed workers may make their deposits.

On top of that, we will create an unemployment insurance scheme that operates in a very similar way to the AFP (pension) system, based on individual accounts in which each worker will be making contributions to be used as savings for potential periods of unemployment.

This will translate into an increase in the national savings rate of 1.5% to 2% of GDP.

LF: Chile will register a fiscal deficit of around 1% in 1999 – the first in 13 years. Given Lagos’ commitment to increasing social spending in education, health and infrastructure, how and when would you expect to achieve a surplus?
AG: We would like to close the deficit by next year, though we think it will be difficult. We expect a 0.2% deficit by the end of 2000. From then on, we should move to reach a 1% surplus in two or three years. To achieve increased revenues, we will rely on economic growth, higher copper prices and a reduction in tax evasion.

LF: Are you willing to let expenditures grow less than GDP until a surplus is achieved?
AG: Yes. We have to do that in order to regain fiscal surplus.LF: Would a Lagos administration contemplate raising taxes to pay for social programs? Under what circumstances would you consider a hike in the current 18% VAT tax?AG: No, we are not considering raising taxes. And under no circumstances we will pursue an increase in the VAT tax.

LF: Are you in favor of eliminating capital gains taxes?
AG: Our first effort will not imply any kind of increases or reductions in taxes. If the decline in evasion were to be large, we could then reduce some taxes. Also, the recently created offshore stock exchange already eliminated the capital gains tax for foreign investment.

LF: Regarding tax evasion, Chile already has one of the lowest rates in the region. And reducing it takes a long time to translate into an increase in revenues. Is it realistic to expect that a reduction in evasion will contribute in a meaningful way to achieve a surplus?
AG: Chile does have low tax evasion if compared to other countries in the region, but it is still very high vis-à-vis European and North American countries. If we reach US standards, we would increase revenues by about $2 billion. And we need half of that in order to increase social expenditures. We will not only reduce tax evasion through better enforcement, but also through tax reform that would eliminate some loopholes, such as tax breaks and VAT exemptions that benefit some types of businesses. Many sectors pay taxes based on their estimated earnings and not on their real ones and the former are always lower than the latter. The objective is to have more horizontal equity in the taxing system.

LF: The opposition accuses you of wanting to impose rigidities in the labor code and increase the power of unions. What are your exact plans in this regard? Do you intend to change company-based wage negotiations for an industry-based system?
AG: We would like to have stronger unions but we do not want to move the collective bargaining process away from the company-based one. We would like to have a larger coverage for collective bargaining since only 10% of companies allow it. In order to do that, we would have to create possibilities for small firms where workers are legally forbidden to create unions. We would actually like to have a more flexible labor market, but one that guarantees the protection of the workers. That is why we want to create unemployment insurance.

LF: Chile recently issued a $500 million sovereign bond. Would a Lagos government resort to doing that again if needed?
AG: We would if needed. But we don’t envision that that will be required. Chile has had and expects to recover soon a surplus in its fiscal account, and the state doesn’t really need foreign financing.

LF: What is the position of the Lagos camp with regards to capital controls? Do you favor the permanent elimination of the encaje, which is currently at 0% but still exists as a mechanism that could be increased, if necessary, to limit capital inflows?
AG: We believe in the autonomy of the central bank and that issue is defined exclusively by them. Our position, though, is that we should not have any type of barriers to foreign investment. But the situation might change as it happened a few years ago, when we were receiving foreign investments that amounted to 10% of GDP. We could not afford so much foreign investment without letting our currency appreciate excessively. Under those conditions, the encaje is called for.

LF: What about the one-year minimum withholding period for direct foreign investments?
AG: That does not have any impact on direct investment. We have surveyed investors asking whether this makes any difference to them, and almost all said that it doesn’t. It does impact foreign pension funds that would want to invest in the country. But we haven’t had great interest in getting large inflows of pension fund investment because we have such high amounts of FDI-which we prefer. If those conditions were to change, we would be in favor of eliminating that restriction.

LF: What privatizations would a Lagos government pursue? Can we expect Codelco to go on the auction block?
AG: The ones that the current government is pursuing: water distribution and treatment, ports and all public utilities that remain in state control. Besides those, there are only two companies in government hands -the oil concern ENAP and Codelco-which we plan to open to private investment in order to allow it to expand into new businesses both inside and outside the country. In the case of copper, we are talking about exploration and exploitation abroad, the development of new mines in Chile, and the production of copper products. Codelco would make joint ventures with firms that do that. But we do not favor the full-fledged privatization of the existing divisions of Codelco. There is no need for that since the company provides an enormous amount of income to the state and it functions in an extremely efficient way. The same is true about ENAP, which is mostly producing abroad in joint ventures with private companies. In Chile, it has also joint ventures in refining oil and gas.

LF: The current law earmarks 10% of Codelco’s earnings for the military. Are you in favor of repealing that?
AG: Yes. The armed forces should get the same money but through budget allocation, which is by far a more stable process considering that copper prices are very cyclical.

LF: Lagos has talked about strengthening the Chilean regulatory framework. What does that mean? What areas or sectors would you target?
AG: In the public utilities sector, some of the supervising institutions are very weak and have a very restricted presence so we would like to strengthen them. Some regulatory frameworks need to be updated, especially those for electric utilities. We would like to introduce some autonomy to the regulatory bodies. In the last four years, we have had two new pieces of legislation for public utilities, the telecom and water sectors, which represent very well what we would like to do with the gas, oil and electrical sectors. The main changes we want to implement seek to foster competition. The environmental agency also needs to be strengthened in order to increase the speed in which it analyzes projects and their environmental impact.

LF: Wouldn’t all these bodies and regulations you envision translate into more bureaucracy?
AG: We do not feel that more employees are required in the public utilities sector. Only better-paid professionals with more autonomy.

In the environmental sector, the supervising unit needs to be expanded. This will require more employees, but there is a long list of projects waiting to be evaluated so more employees might translate into less bureaucracy for the companies.

LF: Will Chile join Mercosur as a full-fledged member even though the country is gearing towards tariffs lower than those of the four Mercosur nations?
AG: We would only join Mercosur if it would transform itself from the customs union it is today into a free trade agreement with lower import duties. I do not see that happening in the very short term. However, Mercosur does have a great strategic importance for us because it transcends into issues of integration, especially in power and infrastructure.

LF: Would Chile pursue accession in Nafta through a bilateral agreement with the US even if Congress does not grant fast-track negotiating authority to the President?
AG: The US and Cuba are the only countries in the Americas with which we do not have some sort of free-trade agreement. And we are already negotiating with Cuba. Therefore, we are certainly interested in completing our agreement with the US, either bilaterally or through Nafta as a whole.

LF: High-level Concertación officials have criticized the central bank’s tightening of monetary policy, proposed monetary punishment for erroneous policy choices and said its forecasts and projections should be measured against the ex-post results. Do you support the central bank’s independence and autonomy as mandated today?
AG: Absolutely. There is no need to change the current law. I do think though that the central bank tightened monetary policy excessively last year and that the country would have benefited if had the central bank kept both the Congress and the public more informed about its targets and actions.

LF: Are you in favor of naming politically independent board members in order to guarantee the independence of the central bank?
AG: The names of the central bank directors are proposed by the President and need to be approved by the Senate. Usually, it is a person considered qualified to be in the position. There are is always political considerations in a process like this one, but we try to keep a balance in the political composition of the board. The most important consideration though is the professional qualifications of the directors.

LF: What would you do to promote more diversification for the AFPs’ investments? Do you think the limits to how much they invest abroad should be relaxed?
AG: The changes we propose aim toward less regulation. We would like AFPs to invest more freely abroad not only terms of the amounts allowed but also in the type of instruments they can buy. We also propose that the AFPs offer their customers a wider variety of accounts from which to chose and have greater possibilities of diversifying their investment inside the country.