In Pursuit of "Growth with Equity": The Limits of Chile's Free-Market Social Reforms

By Pilar Vergara, NACLA Report on the Americas,
May/June, 1996

Pilar Vergara is senior researcher at the Latin American Faculty of Social Sciences (FLACSO) in Santiago, Chile.

The 1990 inauguration of President Patricio Aylwin, head of the Concertacion of Parties for Democracy, a coalition of center and left-wing political parties, marked the end of 17 years of harsh military rule and the beginning of Chile's transition to democracy. The principal motto of the Aylwin administration was "growth with equity"--a notable counterpoint to the neoliberal model implemented by the previous military regime, which maintained that income redistribution could only come from economic growth. While the dictatorship had succeeded in achieving high economic- growth rates--8% annually by the end of the 1980s--income inequalities actually worsened. The number of poor Chileans doubled during the Pinochet regime, and by 1990, 44% of Chileans lived in poverty. The Aylwin government argued that economic growth was a necessary--but not sufficient-- condition for achieving greater equality in Chile. This emphasis on equity was not based only on an ethical concern for social justice, however. The Aylwin administration also sensed that the equity issue was key to the consolidation of Chile's newborn democracy.

The government did not propose either a return to the populist practices of the past--a strategy that other Latin American governments presiding over new democratic regimes had tried, with disastrous results--or a continuation of the dominant neoliberal ideology of the military government. Its proposal was based on the premise that policies promoting economic growth and stability must continue, but that they should be complemented with social policies designed to promote greater equality. The Aylwin administration's approach to equity diverged from the neoliberal model in its emphasis on promoting greater equality among Chileans through social and labor policies directed at the poorest sectors of Chilean society. Nevertheless, it remained firmly within the framework of the free-market model inherited from the military. President Eduardo Frei, also from the Concertacion, was elected to office in 1993. His administration continued the previous government's efforts to make economic growth compatible with achieving greater equity.

Over the past decade, the social reforms carried out by the Chilean military regime have been celebrated as a model for other Latin American countries anxious to overcome the endemic crises of their social-security systems. The policies introduced by the Aylwin and Frei governments to reduce poverty levels within the free-market system, and the initial success of those efforts, reinforced the belief that Chile was a viable model for other countries engaging in social reform. Little attention has been paid, however, to the way the Concertacion governments' redistributive efforts have been hampered by the new social institutions established byJthe Pinochet regime. An examination of the successes and limitations of Chile's social policy reveals how neoliberal social reforms have fundamentally restricted the scope and impact of the Concertacion's attempts to achieve "growth with equity."

Social inequalities had reached unprecedented heights during the 17 years of military rule. The deterioration of basic public services due to constant cuts in social spending under Pinochet affected not only the poorest sectors of society, but also large segments of the middle class. Pent-up social problems had given rise to great expectations of reforms under a democratic government, raising the specter of an explosion of demands that could destabilize Chile's new democracy.

The Aylwin government's capacity to implement redistributive policies, however, was seriously limited by other legacies of authoritarian rule. The military's neoliberal economic policies--including the steady lowering of tax rates and hence government revenue since 1984, the public debt contracted to rescue the financial system after the 1982-1983 crisis, and the end of revenue from the privatization of public enterprises, which were all sold off by 1989--imposed serious budget constraints on the new democratic regime. This impeded the Aylwin administration's capacity to increase social spending without creating fiscal problems.

Within this context of sharp social tensions and budgetary constraints, the government devised an overarching plan, which consisted of three basic elements, to carry out its redistributive tasks. First, the government implemented a tax reform to generate more funds to underwrite the state's social-policy programs. Together with international grants and loans, this tax reform permitted the government in its first year to increase social spending by 17% without provoking macroeconomic imbalances. Resources devoted to social spending increased from year to year. By 1993, social spending had returned to its historic level of 15% of the gross domestic product (GDP), although it remained below 1970 values in per capita terms.

The second element of the Aylwin government's program was the targeting of social spending on the poorest sectors of the population. The government believed that this strategy would help avoid the market distortions that other redistributive mechanisms, such as price controls, caused. New and innovative social programs were designed that focused on social groups such as female heads of household, youth, and indigenous communities. The government increased subsidies to low-income groups, and raised the minimum wage. Primary health care was expanded, and the government invested in new hospital equipment. A program was launched to improve the quality of basic education and to expand the school nutrition program. These programs were implemented in a decentralized manner, and emphasized the participation of the beneficiaries and the promotion of local self-help efforts. Overall, the government gave priority to social programs that represented an investment in human capital, which would promote long-term growth, as opposed to aid programs.

As part of this effort, the government established the Solidarity and Social Investment Fund (FOSIS), whose principal objective is to finance projects that promote productive employment for the poorest sectors. FOSIS does not directly implement projects. Rather, it finances projects designed and administered directly by the social organizations of the poorest communities within each region, often in coordination with non-governmental organizations (NGOs) and other decentralized agencies. The FOSIS has funded 52,000 projects in its four years of operation. These projects, which tend to be small and short-term, are focused on unemployed youth, campesinos, small-enterprise workers, and capacity-building in poor communities. FOSIS initially promised to work closely with existing government ministries, but in practice it often operated independently from them. While this permitted the FOSIS greater flexibility and helped avoid bureaucratic tangles, it also undermined the continuity of the projects.

Finally, the government proposed a labor-reform law, which, after some modification, was accepted by labor, business and the opposition parties, and approved by parliament in 1990. The new law reestablished a series of rights and guarantees that had been denied to workers under the military regime-- including the rights to strike, to form a union, to collective bargaining within productive sectors, and to protection against arbitrary firings or lay-offs. Workers were thereby given the chance to negotiate how the benefits of growth are distributed. Chilean businesses are still allowed to adjust salaries in times of economic loss or macroeconomic changes in order to protect their ability to remain competitive with foreign companies.

This new set of policies registered quick and positive results in the context of strong economic growth. In the three years of Aylwin's administration, the minimum wage increased 24% in real terms, the purchasing power of Chilean families increased 70%, and average incomes grew almost 18%. These upward trends, coupled with the hundreds of new jobs created, led to a significant increase in the portion that household income represented within the GDP. Since 1993, these indicators have continued to improve, though at a slower rate. The crowning achievement of the Aylwin administration's new social policy was the reduction of extreme poverty: the percentage of Chileans living in extreme poverty declined from 44.6% in 1989 to 33% in 1992, and 23% in 1994.

Not all of the Aylwin government's redistributive efforts, however, enjoyed the same levels of success. The limitations of these efforts became increasingly evident during the Frei administration. While the huge inequalities of income distribution that congealed under the military regime had been reduced (though only slightly) during Aylwin's administration, by 1995 they appeared to be increasing again. For example, while the average Chilean family augmented its per capita income by 5% between 1994 and 1995, the poorest 10% saw their income fall by 4.3%. The same concentration of wealth can be seen from a different angle. For the first time since the return to democracy, the annual growth of real incomes fell from 5% in 1994 to 4% in 1995, dropping below the increase of average economic productivity (7.1%). As a result, the income share of GDP fell (34.8% to 33.4%), while the share of capital profit increased (from 38% to 44%).

While Frei has a more openly pro-business bent than his predecessor, he has also encountered a less auspicious environment for his redistributive policies. For example, the government's attempt to extend the 1990 tax reform, which was initially approved for a period of only four years, ran up against the implacable resistance of the business owners' association as well as right-wing opposition parties. Consequently, the Frei administration was stripped of an essential tool to reduce social inequalities. The government's attempt to expand the labor reforms to include non-unionized workers, who represent nearly three-quarters of the labor force, has also run up against a brick wall. After nearly two years, the government has still not obtained parliament's approval for these modifications.

The inability of the government's social policy to go beyond Aylwin's initial achievements and to reverse the widening income gap is also rooted in the way it is currently structured. State social spending has historically been the principal mechanism in Chile through which social inequalities were reduced and channels of social mobility opened. Despite the best intentions of the Aylwin and Frei administrations to overcome fiscal constraints on social spending, however, insufficient resources have been directed to social programs over the past few years, given the magnitude of the accumulated social needs. In 1990, for example, the government-mandated increase of family allowances and workers' minimum pension payments alone ate up half the total funds generated by the new tax reform.

An analysis of the overall impact on living standards of the government's economic and social policies highlights how ineffectual social policy has become as an instrument of redistribution. The reduction of poverty in the first years of the Aylwin administration can be largely attributed to economic growth, rather than the new social policy. It's important to consider that the expansion of employment, which began after 1989, took place as Chile was recovering from a severe economic recession. Growth in real wages during this period was facilitated by the 1990 labor reforms and government-mandated increases in the minimum wage. Furthermore, the drop in inflation improved the overall purchasing power of the population. Once growth rates begin to stabilize and are sustained by increases in productivity rather than the use of idle labor capacity, the benefits for the poor will start to taper off.

Important social groups have been systematically marginalized from the benefits of economic growth, at least in part because they lack the skills and training to join the workforce. This "hard core of poverty"--subsistence farmers, rural migrants to the cities, the elderly, and women and youth who lack vocational training--will only be reduced with the help of specific social policies and programs. While the government has developed social programs directed at the poorest sectors, the amount of resources directed to this sector remains meager. The FOSIS, for example, represented less than 1% of the government's social budget--far too small to have any enduring impact.

An important segment of Chile's middle class, which fell into poverty during the military regime, has also not benefited from economic growth or the government's new social policy. The impoverished middle class lacks the personal resources to pay for private services, but it has also remained largely outside the network of state benefits. The hopes that this group in particular placed in Chile's new democratic governments have been dashed, giving rise to social protests, especially among teachers and health-care professionals who work in the increasingly beleaguered public sector.

A more fundamental problem with Chile's social policy has its roots in the model of social welfare inherited from the dictatorship. Under the military, the state reduced social spending and retreated from the social sector by privatizing social services and creating new institutions guided by the laws of the market. A broad program of reforms, referred to as social "modernizations," transferred to the market and the private sector the task of providing goods and social services previously offered by the state. As a result, the state's capacity to influence the living conditions of the population through traditional social-policy measures was significantly reduced.

A brief look at the reforms of the social-security system and the health sector reveals the underlying principles that guided social-sector reform under the military regime. The privatization of these social sectors gave rise to new institutions that have fundamentally reshaped the provision of social welfare in Chile. The old public social-security system in Chile was based on combined contributions from workers, their employers and the state that were distributed by the government once the worker retired. Reforms initiated in 1981 replaced the old system with a new one based solely on workers' individual contributions, which are administered by private, profit-making entities known as the Administrators of Pension Funds (AFPs). Workers who chose the new system were given "bonds of recognition," which permitted them to transfer their contributions to the old system into the AFPs. While the traditional social-security system continued to be administered and guaranteed by the state, strong incentives--including a reduction of the payment rates from 23% to 13.5%--convinced most workers to switch to the new system. The state had to pay out the accumulated contributions of all those workers who switched to the new AFPs, resulting in the systematic transfer of state resources to the private sector. Every year, a quarter of the state's social budget goes toward these pay-outs. The impact on the old social-security system was devastating: this crucial loss of resources generated a deficit of nearly 5% of GDP within the traditional social-security system, which will last at least until the end of the decade.

Private medicine was also given a boost when the government authorized the establishment of Institutions of Provisional Health (ISAPRES). These profit-making enterprises, which resemble Health Maintenance Organizations (HMOs) in the United States, offer medical services in exchange for an obligatory contribution of 7% of affiliated workers' salaries. While the state still provides health care to the poorest, privatization has ravaged the public health sector. Huge resources that once sustained the state-run clinics and hospitals were transferred to the ISAPRES, resulting in a serious deterioration of the public health system and, consequently, of the health of the poorest who depend on that system. By the end of the 1980s, the ISAPRES were receiving about half of the health contributions of workers, as well as nearly 30% of state expenditures for the health sector, even though they provided health-care services to only 12% of the population.

The way the ISAPRES operate has also contributed to the deterioration of the public health system. Because they are profit-making enterprises, the ISAPRES have excluded elderly people, the chronically infirm, those who suffer from preexisting maladies, and individuals with large families. These groups have been pushed into a public health sector that is increasingly underfinanced, understaffed and underequipped. The majority of the ISAPRES affiliates cannot afford plans that include coverage for costly diseases or health problems. As a result, people suffering from illnesses that demand expensive treatments have little alternative but to turn to the public health system--even though many of them have paid into the ISAPRES system. The already insufficient public health budget is thus further overloaded. In addition, the ISAPRES do not engage in educational activities to promote preventive health care, nor do they cover maternity care or workers' compensation.

This type of social-sector reform has had important implications for the process of capital accumulation. Privatizing social services--coupled with neoliberal economic reforms, including the privatization of public enterprises, tax reductions, and lower overall state spending--has resulted in a transferal of most of the country's internal savings to the private sector. The AFPs alone have accumulated funds totaling nearly 25% of the GDP. By the end of the 1980s, they had become one of the principal investment institutions in the country.

Privatizing the social sector has been good for business, but it has seriously undermined the efficacy and scope of state social policy as a redistributive tool. In effect, the privatization of the social sector created a dual welfare system, in which a private system with high-quality services for high-income groups coexists with an increasingly underfinanced state system that provides services for those who cannot afford private services.

In the end, social spending has actually benefited the poorest the least: in 1993, for example, the wealthiest fifth of the population received nearly double the amount of social spending that the poorest fifth of the population received. This distribution of resources is due less to the inefficiencies of targeting strategies than to the high percentage of the government's social budget that is transferred directly or indirectly to the privatized social- service sector.

Inefficiencies rooted in the persistence of centralization, bureaucratic inertia, and institutional fragmentation within state institutions present further barriers to an effective social policy. In fact, despite all the neoliberal hype, the archaic and inefficient state structures of the past have survived both the anti-statist revolution of the military government and the modernizing efforts of the post- dictatorship governments.

Decentralization, which was initiated during the authoritarian regime and pushed vigorously by the Concertacion governments, has moved forward, as reflected in the new targeted social programs. In practice, however, social policy continues to be designed at the level of the central government. Moreover, the heavy centralist legacy seems to reproduce itself at the local level. The absence of well-trained functionaries in local communities has conspired against effective decentralization, and has reduced the efficacy of local initiatives. The task of restructuring the state social apparatus is admittedly formidable, given its complexity as well as the existence of entrenched interests that will resist change.

Despite these fiscal and institutional constraints, the state does retain some leverage. Pinochet's social reforms reduced the state's role in social policy, but they did not wipe it out completely. While the private sector is now largely responsible for financing and directly administering social programs, the state is still responsible for regulating private-sector activities and setting standards. The state also retains the capacity to determine which elements of social policy should remain part of the public sphere and which should operate in coordination with the market.

Yet, the Concertacion governments have made little use of these powers. If the government had established stronger regulations governing private social-service enterprises, many of their most egregious discriminatory and abusive practices might have been eliminated. For example, the high operating costs of the AFPs, which cuts into the benefits paid to affiliates, could have been reduced by effective regulation. The state could have also imposed rules prohibiting the ISAPRES from refusing to treat high-risk patients and costly illnesses. Stricter controls over the transferal of state resources to social-service enterprises in the private sector would have mitigated the imbalance that Chile now has between a well-funded private social-service sector and a seriously deteriorated public one. Rules governing mergers and takeovers might have thwarted the concentration of social-service enterprises into virtual oligopolies. These harmful practices are extremely difficult to modify now that they have become entrenched--and more importantly, legally sanctioned.

The critical defect of the Concertacion governments' social policy has been their reluctance to revamp the social-sector reforms implemented under Pinochet. Neither the Aylwin nor the Frei administrations proposed modifications in the newly privatized system of social services and the dualism that underlies it. This partly reflects the widespread belief that the privatizations helped resolve the crisis that had characterized the state social-welfare system for decades. At the same time, the Concertacion governments feared that given the social cost of these reforms, Chilean society would have bristled at the prospects of undergoing new structural changes.

This continuity with the social-reform model inherited from the military regime undercuts the viability of obtaining real social equality. By subordinating social programs to the logic of the marketplace, the Concertacion governments-- despite their best intentions--are incapable countering the widening chasm between rich and poor that the neoliberal economic model itself generates. In this model, the state assumes responsibility for ensuring the subsistence of the poorest by providing them with direct subsidies, but it renounces one of the principal social functions it once fulfilled--promoting a genuine redistribution of income.

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