Despite Setbacks, Chile Maintains Economic Liberalization Policy

A policy of open markets and less governmental control is keeping the country on track.
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Chile has long been the poster child for transformed South American dictatorships. A brutal military regime under

Augusto Pinochet

surrenders power peacefully after a plebiscite in 1989. A thriving democracy emerges. Governments under presidents Patricio Alywin and Eduardo Frei eliminate controls on the economy, reduce tariffs and pursue sound fiscal policies. The nation's economy grows at an 8% annual rate. The stock market booms.

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Over the past year or so, however, the luster has worn off the Chilean miracle. First came the fight over Britain's arrest of Pinochet and the attempt to extradite him to Spain to face charges of torture. The episode brought up old tensions for Chileans -- and sent the message that Chile could not be trusted to deal with its own historical ghosts.

Economically, Chile has been hit hard by the global financial turmoil of the past two years. Chile's chief export, copper, was hurt by record low prices. Interest rates were raised last year to prevent capital flight. And this year it suffered a severe drought, hurting agriculture. The result has been a recession that has pushed unemployment to a decade high. Investors have stayed away, turned off by an uninspired stock market performance and overall skittishness toward Latin America. Suddenly, Chile looks less like an economic miracle and more like your run-of-the-mill developing economy.

But don't give up on Chile; it may be turning the corner.

A domestic stimulus program has fueled economic activity. Interest rates have been slashed. Copper prices are starting to rise. Inflation is low. Even the drought has eased. The government estimates growth next year of a very respectable 5%, a figure that independent observers accept.

Although Chile is a bit too dependent on copper, it has a solid economy, with strong fundamentals. The federal budget has been in surplus or in balance for several years. A well-capitalized banking sector helped contain the financial flu of the past two years. Two months ago the government replaced the pegged exchange-rate system with a floating one, although the peso has dropped since then.

Most importantly, Chile resisted the temptation to shut down markets when imports started to rise and exports started to fall. This is in stark contrast to Argentina and Brazil, which have been sniping at each other for the past few months over some trade disputes, and to the U.S., which has seen protectionist pressures rise -- witness the unsuccessful struggle last week to pass the Africa trade bill in the Senate -- despite a strong economy.

In fact, the U.S. might be wise to look to Chile for leadership in the global economy. While the U.S. frets about trade, Chile has been unilaterally liberalizing its economy and lowering trade barriers for several years now. The U.S. wants Chile to join the

North America Free Trade Agreement

, but the Clinton administration lacks the negotiating authority to complete the deal. So Chile went ahead and negotiated separate free trade deals with Canada and Mexico, becoming a

de facto

NAFTA partner, minus the U.S. It has negotiated similar deals with other countries in the region.

Meanwhile, investors continue to avoid Chile because of uncertainty over the upcoming presidential election. Socialist Party candidate Ricardo Lagos, who heads a center-left coalition, is running neck and neck with Joaquin Lavin, a right-wing candidate. Lagos has seen his support drop in recent weeks, a result of discontent over the economic situation. However, both candidates share the basic free-market philosophy and economic policy is unlikely to change. (Lagos must be the only free-trade socialist in the world today.)

One spillover effect of the election could benefit investors. The major exception to Chile's free-market philosophy is a capital control restriction, known as the

encaje,

which requires investors to hold their purchases for one year. The government has reduced that over the years (it used to be five years) and there is a strong possibility that it will completely eliminate it soon. Such a move could cause a rise in the stock market and an increase in confidence in the economy. Frei would not mind giving such a boost to Lagos. In any case, because both candidates support ending the

encaje,

it will probably be eliminated by next year.

Chile's poster may be a bit worn and frayed in some areas. But not for long.

David Kurapka wrote speeches for Treasury Secretary Robert Rubin from 1996 until 1999. Before that, he was U.S. Trade Representative Mickey Kantor's speechwriter from 1993 to 1996. Kurapka writes from Oakland, Calif.