With reference to the information provided and your own knowledge, evaluate the microeconomic and macroeconomic impact on Chile’s economy of changes in the level of investment (25)
Figure 2: US dollar per 100 Chile pesos exchange rate, 2007–2015
Extract A
Chile’s economic outlook brightens
Chile has been hit hard by a worldwide fall in commodity prices since 2011. Copper accounts for 20% of Chile’s GDP and 60% of its exports; one third of the world’s copper is produced by Chile. China purchased 40% of the world’s copper, so a slowdown in China combined with increased global over-supply has meant copper prices have collapsed (see Figure 1). Chilean government income from copper exports had reached $11.5 billion a year before copper prices fell, but now tax revenues from this source have fallen drastically. Growing numbers of copper mines struggle to break even at current prices.
Chile’s GDP is now growing, helped by a weak currency that has boosted export industries outside the mining sector, such as its successful wine and salmon industries. There are strengths in tourism and high-tech products. Public services are good in Chile, and poverty rates have been falling fast. On top of this, a large and diversified financial sector with high domestic savings provides a useful safety net, given high levels of corporate debt and the government’s need to finance a fiscal deficit of 3% of GDP.
Chile’s economy is often regarded as the best run in the region. This is attributed to the credibility of its financial institutions, relatively low levels of national debt (about 15% of GDP) and its free-trade model, which is unrestricted by government interventionism that has distorted the economies of countries such as Argentina and Venezuela. “Chile is an example of how credible institutions can smooth the economic cycle and make adjustments less traumatic,” said Mr Valdés, the minister of finance in Chile, pointing to its widely respected and independent central bank and a well-established fiscal rule that give officials the freedom to implement counter-cyclical policies.
However, there are worries that without enough spare capacity in the economy, expansionary fiscal and monetary policies could end up increasing inflation rather than economic growth. Meanwhile monetary policy is restricted by inflation that has reached 5%, well outside the central bank’s 2–4% target range, fuelled by a weaker exchange rate. Crucially, investment remains low because of uncertainty over the outcome of the Prime Minister’s reforms, which are aimed at reducing inequality. A recent rise in corporation tax from 20% to 25% and labour market reforms that strengthen the power of trade unions may have a negative effect on business confidence.
Despite a “mildly contractionary” budget, Valdés insisted that the government would continue with costly reforms. Increased taxes on those on higher incomes are considered by the government to be necessary to sustain economic development in Chile. “We do want to change society, while recognising all the good things that have been done in the past 25 years,” said Mr Valdés, referring to an average growth rate of 5.3% over the past three decades, but under 2% in 2015. There is broad consensus that investment in education is the key to unlocking Chile’s growth potential.
(Sources: adapted from http://www.ft.com/cms/s/0/89926ce8-df96-11e4-a6c400144feab7de html#axzz3pCnzT3PC FT 20 April 2015 and http://www.ft.com/cms/s/0/d60ac2b2-7453- 11e5-a129-3fcc4f641d98.html?siteedition=uk#axzz3pCnzT3PC FT 19 October 2015 and http://www.ft.com/cms/s/0/d60ac2b2-7453-11e5-a129-3fcc4f641d98.html?siteedition=
1 mark
