Sectoral Growth in Chile: 1962-82

The agricultural share of a country's total output generally declines in the process of economic growth. The major reason for this is that consumer demand for food increases only slightly with rising incomes. However, a small, open economy can overcome this constraint to the growth of agricultural production by expanding its net exports. Chile serves as a good example. Its share of agriculture in total output averaged 9.46 percent during 1986-90, compared with 9.66 percent in 1960-64 9 (Figure 1). The relative long-term constancy of this agricultural share in Chile presents a sharp departure from the experience of most countries. The option of maintaining such a constant share is not open to all countries, but the Chilean experience is of general interest for a variety of cases, as shown in Sectoral Growth in Chile: 1962-82, Research Report 95, by Juan Eduardo Coeymans and Yair Mundlak.

Change in the agricultural share in total output reflects the growth rates of all sectors of the economy. These rates varied considerably over time in Chile as elsewhere. To understand the time path of agricultural development, the causes of the variability in sectoral outputs must be examined as part of the general process of economic growth. The Chilean economy is a particularly interesting case for such a study in view of the various policies that have been tried out in Chile over a short time span. Most studies of the consequences of such policies have concentrated on the short term, and little has been said about their long-term effects on overall and sectoral growth.

Growth and Sustainability

The post-study period from 1983 to date has been a period of vigorous growth in Chile. Whether the current growth performance is sustainable is the subject of an ongoing discussion within the country. This public discussion is partly political and partly emotional and lacks a quantitative framework. Yet it has important repercussions. An overestimation of the growth rate may lead to overspending and debt accumulation with all the negative consequences, such as an outflow of capital, observed in the 1970s when medium-term growth was overestimated.

The literature on theoretical economic growth concentrates mainly on the long-run aspects of the growth process, trying to understand the forces that augment the frontiers of knowledge and technology. It does not take account of the effect of the current economic environment on the use of resources under existing technology. Can such an approach to the study of growth provide a good guideline for empirical analysis? This review of the Chilean experience shows that during 1936-70, per capita income grew at a fairly steady rate of 1.6 percent a year (Figure 2). Growth was interrupted as a result of internal political shocks beginning in 1970, followed by external shocks that led to a decline in output and culminated in the recessions of 1975 and 1982. Both the fall and subsequent rise of output are results of general and agricultural policies that affected the economic environment and growth performance. Consequently, the study finds that Chile's record is not related to advances of knowledge and technology but rather to implementation of what is already known.

Many economic discussions differentiate between short-term variations and long-term growth, but this is not possible in empirical analysis because the data are not divided accordingly. For instance, investment is a key variable in the discussion of growth, and at the same time, variations in investment are strongly associated with short-term variations in total output. The data are always determined in the context of short-run equilibria. This study attempts to distill the long-run processes from the data. However, the task is somewhat difficult because of the turbulent environment that prevailed in Chile during the second half of the study period.

Growth cannot be detached from current events. Changes in the economic environment--such as external terms of trade, flows of capital, government expenditures, and finance or sector-specific policies such as subsidies to agriculture or the protection of manufacturing--all affect the performance of the economy through the price mechanism and the availability of resources for production. Differences in product prices also affect the prices and sectoral allocation of inputs. The introduction of new and more productive techniques of production requires a profitable environment as well as capital. In an open economy the flow of capital depends on domestic profitability and stability relative to the rest of the world, and on the degree of openness of the economy.

Sectoral Analysis

To capture all these relationships within an analytic framework, the study divides the economy into five sectors: mining, agriculture, manufacturing, services, and government, listed in declining order of tradability. The production of each sector uses labor, capital, and intermediate inputs provided by other sectors. The study provides an input-output table that shows the flow of goods among sectors. The technology of production is determined by the economic environment in that the techniques of production actually used are determined by sectoral incentives, availability of resources, and available technology. The sectoral incentives are strongly affected by macroeconomic and trade policies and by international terms of trade. The allocation of labor between agriculture and nonagriculture depends on the differential income between these two sectors. This is the reason that the share of agriculture in total employment in the study period shows a decline (Figure 1), while its share in output is roughly constant. On the other hand, employment in nonagricultural sectors is determined by labor demand conditions as well as wage rates. The wage rates are affected by the degree of unemployment and also, in the short run, by variations in the inflation rates. Investment is allocated to the various sectors according to their relative profitability as determined by the rates of return.

Sector-specific policies affect sectoral prices and thereby sectoral outputs. Such effects are examined in the study by simulating the response of the economy to price changes. The response of agricultural output to a 1.0 percent change in its price results in a 0.3 percent increase in agricultural output in 3 years and a 1.0 percent increase after 10 years. This corresponds to implicit supply elasticities of 0.3 and 1.0 after 3 years and 10 years, respectively. On the other hand, an increase in the price of manufacturing by 1.0 percent leads to a 4.0 percent increase in output after 10 years, implying a supply elasticity of 4.0.

The study notes that the reason for the gradual response to a price change is that changes in the structure of the economy require reallocation of resources, which is time-consuming. The time needed varies by sectors, reflecting the nature of factor supply, and thus is not specific to changes caused by price changes. Because a similar pattern is expected to exist in response to other changes in the economic environment, there are no shortcuts for changing the structure of the economy--a point that is often overlooked in the discussion of policy.

The weak response of agriculture in the short run explains the pessimism of structuralists about the effect of price policy on agricultural output. The essence of the results in this study is that the response is rather sizable but requires time to materialize. This distinction between magnitude and speed is extremely important in that it highlights the importance of having persistent economic policies.

The study finds that the stronger response of manufacturing was facilitated by drawing resources from services, with mining contributing to the expansion of manufacturing capital. This illustrates that the development of manufacturing need not be at the expense of agriculture, as is often implied in the development literature that proposes taxing agriculture as a means of developing manufacturing.

Underlying Influences on the Economy

The main events in the study period were the outcome of general, rather than sector-specific, policies. Such policies affect the level of domestic prices and thereby the real exchange rate--the price of tradable goods in terms of nontradable goods. The index of the real exchange rate varied in the study period from 77 to 131 and climbed to still higher levels in the post-study period, reaching 147 in 1985. A change in the real exchange rate affects sectoral prices according to the sector's degree of tradability; the more important the tradable component in sectoral output, the more susceptible the sectoral price to changes in the real exchange rate. The strength of the effect is directly related to the degree of openness of the economy. Indeed, the study shows that a simulated increase in the real exchange rate causes a strong increase in the output of mining and agriculture, the more-tradable sectors. The resources needed for the expansion of these sectors are provided by services, which is the least-tradable sector. The importance of the real exchange rate for agriculture has become evident through the growth of agriculture in the last decade, which is largely outside the study period.

An extremely important feature of the Chilean economy in the study period is the resiliency of real wages in nonagriculture. The study shows that any simulated improvement in the economy that leads to an increase in labor demand has a stronger effect on wages than on employment. This result reflects institutional arrangements and social norms that interfered with the market performance and thus choked up the growth process.

The political and economic volatility during the study period caused the investment-output ratio to fluctuate during 1960-90 in the range of 13-23 percent (Figure 3). To evaluate the cost of the political instability of the 1970s, the study simulates the economy under the assumption that the ratio is maintained at a 20 percent level, which was typical for the 1960s. The simulation begins in 1974 and the effect is dramatic; in 1982, eight years after this change is introduced, output increases by 20 percent under the assumption that wages remained at their historical level. Furthermore, unemployment in 1982 would have declined by 11.2 percentage points.

Because it is a small economy, Chile depends greatly on its relationships with the world economy. External terms of trade affect its economy and historically have been the cause of business cycles. An improvement in the terms of trade has a favorable effect on the volume of trade and therefore on the introduction of new techniques, which causes an irreversible technical change. A similar effect is obtained by keeping the economy open to trade and to capital flow. The cyclical variations affect growth, and the study finds that during recessions there was less incentive to expand technology. Favorable external conditions affected positively the productivity of nontradable products.

Chile implemented a major agrarian reform during the 1960s and early 1970s. The study analysis shows that the reform had a slight positive effect on agricultural output in its beginning and a negative effect in the final years. However, there is no evidence of the strong positive effects that are usually expected of land reforms.

Policy Implications

The study of intersectoral resource allocation and productivity changes in response to the economic environment is pertinent for any topic related to the supply side of the economy. Specifically, it is essential for evaluating the effect of trade liberalization or free trade agreements such as NAFTA (North American Free Trade Agreement) and MERCOSUR (Mercado Común del Sur) in the southern cone of Latin America. The welfare flow of such agreements is determined by the direction as well as by the speed of adjustments in resources and productivity.

The most important lesson learned from the Chilean experience is that economic policies should be sustainable and persistent. Myopic policies, whether carried out for reasons of political opportunism, ideology, or ignorance, are very costly in terms of growth, and because they are not sustainable they are also costly in terms of the adjustments that are needed to reverse their negative effects. Understanding the motives for wrong policies is a lesson in social behavior but is not a remedy for the social cost.