Thursday, January 16, 2020

A chilly Chilean lesson

I have been interested in following the news from Chile.

Most recently, I found this very interesting essay by Avel Kaiser in the Jan 1 Wall Street Journal. An excerpt:
Latin America’s freest, most stable and richest nation—is in free fall. Public order has collapsed, violence is rampant, and populism is the new creed of the political class. 
There is a recession, characterized by capital flight and rising unemployment...
It took a mere 40 days for the Latin American “oasis”—as President Sebastián Piñera called Chile not long ago—to vanish. How a stable and prosperous Chile fell so dramatically in such a short period is a lesson for every Western democracy. 
Coordinated protest groups destroyed almost 80 subway stations, bringing Santiago’s public transportation to a halt. Rioters attacked public and private property. 
...The economic pain started with the antimarket reforms of the previous government under Socialist President Michelle Bachelet, 
The policies result from a profoundly false narrative Chilean elites tell themselves about the country. Over the past 20 years, intellectuals, media personalities, business leaders, politicians and celebrities in this Latin American nation have marketed the myth that Chile is an extreme case of injustice and abuse. It began at the universities, where progressive ideologues spread the idea that there was nothing to feel proud about when it came to Chile’s social and economic record...“neoliberalism” had created a society of winners and losers in which neither group deserved the position in which it found itself. 
... Even Mr. Piñera, a billionaire, accepted the basic premises of the progressive elites’ narrative. In his first term he raised taxes to address what he called one of Chile’s main problems: inequality.  
Chilean elites are waging a sustained war against law enforcement. Many police officers don’t dare act for fear of sensationalist media coverage and punishments by courts under the sway of progressive elites. The same is true for the military. 
The free market didn’t fail Chile, whatever its politicians might say, and the state doesn’t lack the means to restore the rule of law. The central problem is that a large proportion of the elites who run key institutions—especially the media, the National Congress and the judiciary—no longer believe in the principles that made the country successful. The result is a full-blown economic and political crisis. Other nations should take note: This is what elite self-hatred can do for you.
My emphasis, and the central point for today. Societies fall apart when the people who run its central institutions no longer believe them worth defending. Sometimes they're right about that -- Soviet Union. Sometimes they're not. The lessons for the rest of us are obvious. 



Easier coverage of the swift decline include Mary Anastasia O'Grady in the Wall Street Journal last October 27:

left-wing terrorists savaged Santiago and cities around the country with violence. 
This happened in a nation that, as the newspaper La Tercera reported on Oct. 5, has seen the poverty rate fall below 9%, down from 68% in 1990. Income inequality has also been coming down. 
On Saturday over a million demonstrators poured into the streets of Santiago to voice grievances—reportedly everything from the high cost of living to income inequality and climate change. 
Yet it is unlikely that the eyes of the world would be on Chile if not for the perpetrators of violence, who took advantage of the moment to wreak havoc and demand a new constitution 
But the hard left has spent years planting socialism in the Chilean psyche via secondary schools, universities, the media and politics. 
Even as the country has grown richer than any of its neighbors by defending private property, competition and the rule of law, Chileans marinate in anticapitalist propaganda. The millennials who poured into the streets to promote class warfare reflect that influence. 
The Chilean right has largely abandoned its obligation to engage in the battle of ideas in the public square. Mr. Piñera isn’t an economic liberal and makes no attempt to defend the morality of the market. He hasn’t even reversed the antigrowth policies of his predecessor, Socialist Michelle Bachelet. Chileans have one side of the story pounded into their heads. As living standards rise, so do expectations. When reality doesn’t keep up, the ground is already fertile for socialists to plow. 
The violence has another explanation. To chalk it up to spontaneity requires the suspension of disbelief. As one intelligence official in the region told me Friday: “It takes a lot of money to move this number of people and to engage them in this level of violence.” The explosive devices used, he said, were “far more sophisticated than Molotov cocktails.”
Writing Nov 3, she adds
Negotiations with terrorists and their political representatives seldom end well. Yet that’s what Mr. Piñera seems to have in mind. He has opened the door to rewriting Chile’s Constitution to meet the demands of socialists, communists and others on the left.
The new constitution is apparently happening. This may be the Estates General all over again.
If Latin American history is any guide, a constitutional rewrite will strip away political and economic rights, concentrate power and leave the nation poorer and more unjust.
Mr. Piñera has agreed to talks with the “citizens” whose interests are presumably represented by the firebombers and looters. Last week he announced that he would not rule out any “solution” or “structural reform.” On Wednesday government spokeswoman Karla Rubilar, with regard to a new constitution, said “there is nothing written in stone.”
It's hard to think of a case that introducing profound changes to a country's order in response to mobs has worked out well. Some revolutions end well, ours. Many do not. Some old orders were worth preserving. Some were not. But the mechanism has been seen many times before.
This is a stunning surrender and it is hardly surprising that it seems only to have whet the appetite of the radical left.
What isn’t debatable is the economic gains, across the board, that the market model has created. Less than 9% of the nation now lives below the poverty level. In a 2018 Organization for Economic Cooperation and Development report titled “A Broken Social Elevator? How to Promote Social Mobility,” Chile stands out for its social mobility.
Yes, some say that young Chileans don't know history. But can they not see Argentina,  Venezuela, Cuba? Can they really believe the same medicine will work for Chile, if only different doctors hand it out?

Update: Thanks to @Shekhar_HK17, here is a somewhat different view on the inequality question from Sebastian Edwards. Excerpt:
Chile’s Paradox
The data discussed above shows a (relatively) positive picture. But, behind these rosy figures, there is a big paradox: While conventional indicators show a significant decline in inequality, the perception among Chile’s citizens is that inequality has greatly increased—See Figure 4. 
This contrast between “reality” and “perception,” constitutes “Chile’s paradox.” There are three possible explanations for it: 
The first is that we are talking about two different meanings of “inequality.” While most economists focus on “income inequality,” as measured by the Gini, the people are talking about a broader concept, one that includes quality of life, social interactions, access to basic services, the nature of interpersonal relations, and the degree of “fairness” of the political and economic systems.
Second, it is possible that people don’t realize that conditions have greatly improved. It is conceivable that the narrative about the county’s social and economic trajectory has been captured by the left and by the critics of “neoliberalism.” This is a “veil of ignorance” type of argument. 
The third possible explanation is that people recognize that there has been progress, but believe that things are moving too slowly. This is an “impatience” argument that compares reality with aspirations. The disconnect between the two is captured vividly by the privately run pensions system. While people expected—and were promised—a high replacement rate, this has been, on average, a very low 30 percent.
Which of these three possible explanations is correct? As in the old SAT question, the right answer is “all of the above.”
I still resist the nostrum, passed around as known fact, that "inequality" produces social and political discontent. It's really hard to see inequality. It is a problem of statistics, not of daily life. The perception of inequality -- what we used to call envy -- and "inequality" as a political slogan is a powerful force to be sure.

The puzzle is that every income class in Chile has gotten better off than their counterparts in other Latin American countries.  Why would they want to go back to I get poorer but you get poorer still so we are less unequal? 

20 comments:

  1. Am I naive to worry that the US could be headed down this path? And if so, how do we stop it? Do we need another Milton Friedman to bombastically refute the vociferous left?

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    1. Friedman was such a unique individual; passionate AND convincing! Moreover, the country is moving inexorably left-and Trump is NOT helping.

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    2. That's not helping, from JFK to Bill Clinton to AOCs boyfriend violating all kinds of campaign standards the left doesn't need more help with it's ridiculous double standards. If you insist only saints can pass econ 101 you'll be ruled by those who failed it.

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  2. It's certainly difficult to have faith in institutions if the institutions have largely failed the population. North was right (former Senior Fellow at the Hoover Institution, too!). Institutions matter. Path dependency is extremely critical - even if it does borrow bits of institutional/cultural DNA from past institutions (like the US did with borrowing bits from the Parliamentary System in the UK).

    There also seems to be a phenomenon related to how fast information is delivered and how it affects decision making. With the Internet, Social Media, and all sorts of news outlets, people get information very quickly and it *seems* they react accordingly: quickly. There seems to be some sort of measured contemplation that is missing, which takes time. The idea is the world appears to be changing very quickly and people react accordingly - may seem obvious, yes, but it is difficult to weigh options if people are reacting without thinking.

    Best,
    M

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  3. For a course of microeconomics (price theory, general equilibrium and other topics) I wrote an essay about this social crisis. In this, the thesis is not focused in the beliefs of the elite, but in the walk of the Chilean economy during the last 15 years. Of course the thesis of Kaiser is interesting and I agree with it, but I think that is necessary to observe what about with the economic growth. Even, an interesting underlying question of this issue is why people care about inequality: economic efficiency, feel of fairness and/or they think they'll be benefited with a more egalitarian re-distribution?

    Regards,
    Gonzalo Viveros, undergraduate student of Business and Economics at P. Universidad Católica de Chile.

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    1. People don´t care about inequality. They have been told inequality matters but nobody has properly explained why is so. It is a "religious belief" not a fact:

      *there is no correlation between "lack of economic efficiency" and "inequality". It is actually closer to the other way around

      * Equality is not fair. Why should it be?. Most of the inequality you can observe around has been "earned" fair and square. If rent seeking is a significant problem, there are specific solutions to address that and it is very unlikely that these solutions involve and expansion in the size of the government.

      * To think that "a more egalitarian re-distribution" would benefit a significant amount of people, requires a significant geopolitical ignorance or the suspension of disbelief or both. Venezuela or Cuba are vivid examples of how mistaken can be the "religious faith" in the benefits of a more egalitarian distribution.

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    2. I agree but people not necessary believe in what is correct. Specifically the point of whether the inequality is unfair (or how unfair could be) I think is a normative issue. For other side, income re-distribution brings winners and losers; there will be some percentiles that improve their income and other that their income drops.
      Anyway, the question is about how people actually behave. I asked me this in the essay by a brief "paper" of Rodrigo Valdés -former Finance Minister of Chile during M. Bachelet's goverment (2014-2018)- that concluded that, after all, Chileans like their economic system (paper was released in the Harvard's alumni magazine).

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  4. Unfortunately, Chileans are falling prey to the demagogical populism so prevalent in South American (think Peronism, Evo Morales, Hugo Chavez, Lula). It is very sad to see. I would have thought that after many years of very decent economic policy and economic training by very good academics trained in the best schools, that Chileans would be different.
    But no, they fell prey, and as Prof Cochrane says, the Piñera government did not defend it.
    My wild guess is that this started with President Michelle Bachelet. She started this demagoguery of free stuff, as if stuff had no cost.
    And then, it went downhill from there.
    It will be very, very difficult to turn this around. Once the free stuff mindset sets in, you cannot dislodge it.

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  5. Muy buenas columnas ambas, para los que tenemos 30 años o más, nos recordamos perfectamente como era el Chile de los Noventa, coincido que si bien el modelo puede ser perfeccionado, es totalmente irresponsable pensar que uno nuevo este destinado al éxito, muchos jóvenes exigen la vida, pero no trabajar por ella y ese modelo existió y fracasó. Aquel que ha leído historia y que tenga un mínimo de conocimiento económico sabe eso.
    Si ha eso le sumamos la violencia, el resultado todavía es peor
    Las sociedades deben tener libertad de pensamiento, expresión y crear espacios para desarrollar ideas que den frutos para mejorar la calidad de vida de las personas.

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  6. I think the neo-liberal model has worked, but anything is perfect, there are market failures (that must be corrected) . The problem that young people think in the utopia of communism (failed model), a welfare state, they want free lunch, and with these mentalities, Chile would have 2 options; be as (1) Argentina (2) Venezuela.

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  7. I think the neo-liberal model has worked, but anything is perfect, there are market failures (that must be corrected) . The problem that young people think in the utopia of communism (failed model), a welfare state, they want free lunch, and with these mentalities, Chile would have 2 options; be as (1) Argentina (2) Venezuela.

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  8. Axel Kaiser analysis are usually exaggerated. For example he predicted a currency crisis (the peso going to $1000) which didn't happen. Yes, there was an ~8% depreciation which happened before his prediction, but far from a currency crisis.

    Also, there is no technical economic recession and growth is expected to be positive for next year. I expect the unemployment rate to go up, but the last published numbers were better than expected by most (almost no variation IIRC).

    He mentions that "the left has been planting socialism", when I see no party (except the communist party, which is very small) asking for 'socialist' policies. The "hard" left is similar to Warren/Sanders, and the center-left is similar to Biden.

    Moreover, many people who believe in market oriented policies feel that in Chile we got most of the gains of freer markets. We have great free trade agreements, low taxes, an open economy, a reliable central bank, low inflation, low corruption, low crime, but also low growth. Our exports are commodities and our economic complexity is low. Piñera's solution to this (before the social crisis started) was to reduce taxes even more (our taxes are significantly lower as a % of GDP when comparing to the US). This, in my book, seems naive for a country like Chile.

    You also mention that inequality is hard to see, well in Chile is quite easy. If you go to a rich neighborhood it looks like the US or any other developed country, go to a poorer neighborhood and you can find slums which you don't find in those countries.

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    1. I had never heard of Axel Kaiser, so I had no pre-conceived notions about him, But listening to him here (sorry, but in Spanish) https://www.youtube.com/watch?v=A3l_S5n3-p8 was chilling: not because his rhetoric is indeed passionate, but because his analysis was not. And it was pessimistic. His analysis and data is not that different from Sebastian Edward's -- who can not possibly be labeled as anything but a reserved NGO economist. Finally, it troubles me that people like Axel are so hounded by protesters intent on "cancelling" his talks -- in Zurich, e.g -- such that the group in Madrid that hosted him for this discussion had to do conceal where and where he was speaking. There is no doubt that Chile must address its (slow) growing pains. The problem is that the neoliberal Center-Right ceded the narrative to the Progressive Left who has ceded the enforcement to the antifa-like Left. The solutions will not be pretty.

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    2. As far as i know, Axel Kaiser did not predicted a time range for the USD to reach $1000 chilean peso, so criticizing his analysis based on that is at least dishonest or shortsighted. Give it time.

      Regarding your second criticism about not having technical recession, that might be true in an aggregate level, but specific industries are in freefall since Bachelet tax reform (Mining projects, construction not including residential that i know of first hand). And if the company you work for goes bankrupt, you do not lose a % of your income proportional to the loss in GDP, you lose your complete income.

      About seeing no socialism, that might be true if you just consider what people call their ideology, but if you look into the proposals themselves, they are pure socialism, no matter what you call them. People on the streets are claiming for socialism, whether they dare to name it like that or not.

      Piñera hasn't reduced taxes one bit from Bachelet, even moreso, i think his tax reform would increase them, although make the tax code simpler.

      What you say about income inequality is right in part, La Cisterna (poor neighborhood) looks very different from Vitacura (rich neighborhood) in Santiago. But just looking at a still picture is also dishonest, because living standards of the poor have risen hugely from the 1990s. During the 1990s, outside Santiago, the government was just building kitchens and bathrooms for poor people, nowadays almost everyone in Chile has running water and enough food. Not so long ago it was not the case.

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  9. There is a lot of intellectual dishonesty in blaming economic problems on the rise of socialist ideas. Let's begin to admit that the real culprit is capitalism gone bad. Free capitalism leads to wealth concentration. When that happens, the ruling elites no longer want a free competitive market and start rigging the game. When the population realizes what is going on, they lose faith in capitalism and start advocating redistributive policies inspired by socialism.
    Socialism is the outcome, not the cause.
    In Chile, like in the US, a crony capitalist system has taken hold which is eroding the economy, creating inequality and making people lose faith in free markets.

    Let's discuss more how to deal with crony capitalism rather than blaming it all on socialism.

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    1. Do you have any evidence to back up the following claims.

      "Free capitalism leads to wealth concentration"

      "In Chile, like in the US, a crony capitalist system has taken hold which is eroding the economy..."

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  10. It is cultural.....Have you ever tried to convince someone of something s/he is emotionally invested in? Even if they experience the opposite of what they believe, e.g., things are better, than worse, their emotional investment woes not let them admit error. Only when they experience a steep collapse of their beliefs, will they change their minds. Cubans committed to Castro, Maduroites in Venezuela, and Socialists in the U.S., cannot/will not change until reality takes place, and material, security, and individual freedoms detriorate massively. Things get worse, before they get better....

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  11. Chilean high middle class is not better off, they just have less kids than their parents.

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  12. Dear Professor Cochrane, thank you very much for your interesting post. I disagree completely with Mr.Kaiser view that Chile is in “free fall”. Despite all the unrest, destruction and deaths, Chile is still (January 2019) the country in America (continent) with the lowest risk premium (behind Canada and the USA). It has access to financial markets and the economy is, despite everything, working well. From a macroeconomic perspective Chile is, indeed, the most successful country in Latin-America. This is also the view of international financial markets.

    Chile, however, lags behind in most social indicators when compared to OECD countries. It has the worst income distribution in the OECD (yes, worse than Mexico). It has low social-mobility and it lacks competition among elites (see recent AER paper from a Chicago professor on this issue https://pubs.aeaweb.org/doi/pdfplus/10.1257/aer.20171019). According to a recent survey by CEP (https://www.cepchile.cl/cep/encuestas-cep/encuestas-2009-2018/estudio-nacional-de-opinion-publica-n-84-diciembre-2019), income inequality is indeed the main reason for social unrest, followed by low pensions and high living cost.

    In my view, one key element behind the recent protest is lack of competition and the widespread rent-seeking behavior by firms, which is both inefficient and exacerbates income disparities. This was already been noted in 2012 by The Economist (https://www.economist.com/americas-view/2012/02/02/the-shine-comes-off). Sadly, since then more and more cases were discovered. Many see this type of rent-seeking behavior as an evidence of the “evil” nature of capitalism when it is just the opposite! Hence, and this may come as a paradox to many, more free market oriented policies and tougher sanctions on market collusion should be at the top of the policy agenda in Chile. Alas, Chilean scholars who are funded by interest groups (private firms) may fail to recognize that this type of polices are much needed.

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  13. Dear Professor Cochrane, thank you very much for your interesting post. I disagree completely with Mr.Kaiser view that Chile is in “free fall”. Despite all the unrest, destruction and deaths, Chile is still (January 2020) the country in America (continent) with the lowest risk premium (behind Canada and the USA). It has access to financial markets and the economy is, despite everything, working well. From a macroeconomic perspective Chile is, indeed, the most successful country in Latin-America. This is also the view of international financial markets.

    Chile, however, lags behind in most social indicators when compared to OECD countries. It has the worst income distribution in the OECD (yes, worse than Mexico). It has low social-mobility and it lacks competition among elites (see recent AER paper from a Chicago professor on this issue https://pubs.aeaweb.org/doi/pdfplus/10.1257/aer.20171019). According to a recent survey by CEP (https://www.cepchile.cl/cep/encuestas-cep/encuestas-2009-2018/estudio-nacional-de-opinion-publica-n-84-diciembre-2019), income inequality is indeed the main reason for social unrest, followed by low pensions and high living cost.

    In my view, one key element behind the recent protest is lack of competition and the widespread rent-seeking behavior by firms, which is both inefficient and exacerbates income disparities. This was already been noted in 2012 by The Economist (https://www.economist.com/americas-view/2012/02/02/the-shine-comes-off). Sadly, since then more and more cases were discovered. Many see this type of rent-seeking behavior as an evidence of the “evil” nature of capitalism when it is just the opposite! Hence, and this may come as a paradox to many, more free market oriented policies and tougher sanctions on market collusion should be at the top of the policy agenda in Chile. Alas, Chilean scholars who are funded by interest groups (private firms) may fail to recognize that this type of polices are much needed.

    ReplyDelete

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