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ChileDevelopment Policy Review
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Document of the World Bank | Report No. 33501-CL | June 2006 | Poverty Reduction and Economic Management Unit | Latin America and The Caribbean Region
C H I L ED e v e l o p m e n t
P o l i c y R e v i e w
V o l u m e 1 : S u m m a r y R e p o r t
ACCIF Average Country Citation Impact Factor
AFP Chile's Private Pension Fund System
(Administradoras de Fondos de Pensiones)
AGR Agriculture Sector
AUGE Plan of Universal Access with Explicit Guarantees
BPF Bono de Protección Familiar
CAI Cuenta de Ahorro de Indemnización
CAS Country Assistance Strategy
CASEN Chile's National Household Survey
COM Commerce
CONAF Chile's National Forest Corporation
CONICIT National Commission of Science and Technology
CORFO Industrial Development Corporation
(Corporación de Fomento)
DIPRES Budget Office, Ministry of Finance
(Dirección de Presupuestos)
DPR Development Policy Review
EGA Electricity, Gas and Water Sector
EU European Union
FDI Foreign Direct Investment
FECU Financial Equity Companies in USD
FEDIT Spanish Federation of Technological
Innovation Entities
FIA Fundación para la Innovación Agraria
FONASA Publicly Run Social Health Insurance System
(Fondo Nacional de Salud)
FONTEC Fondo Nacional de Desarrollo Tecnológico
y Productivo
FOSIS Social Development Fund Financed by Chilean
Government (Fondo de Solidaridad e Inversión
Social)
FSSA Financial Systems Stability Assessment
FTAs Free Trade Agreements
FTE Full-Time Equivalent
GDP Gross Domestic Product
IMF International Monetary Fund
IND Industry
INE National Statistics Institute
LAC Latin America and the Caribbean
LDC Lower Developing Countries
MIDEPLAN Ministry of Planning and Cooperation
MIN Mining Sector
MINEDUC Chile's Ministry of Education
MPG Contributory minimum pension guarantee
NIS National Innovation system
NSF National Science Foundation
Currency Unit Chilean Pesos (CLP)
US$1.0 CLP $534.75 (September 7, 2005)
Fiscal Year January 1 to December 31
C u r r e n c y E q u i v a l e n t s
A c r o n y m s a n d A b b r e v i a t i o n s
Re
fere
nce
s
NPV Net Present Value
OECD Organization of Economic co-operation
and Development
OMIL Oficina Municipal de Intermediación Laboral
OTC Over-the Counter Instruments
PACES Colombia's Targeted Voucher Program
PASIS Non Contributory, Social Assistance Benefit
to Elderly Indigent
PAYGO Pay-as-you-go Financing for Social Insurance
Institutions
PEE Plan Especial de Empleo
PEPs Public Employment Programs
PISA Programme for International Student Assessment
PMU Survey of Households in Grater Santiago
PRIESO Chile's Social Risk Management Survey
PRIs Public Research Institutes
PROGRESA Programa de Educación, Salud y Alimentación
PSU University Entrance Exams
R & D Research and Development
RICYT Ibero-American and Inter-American Network on
Science and Technology Indicators
SBIF Communal Services
S&T Science and Technology
SCI Science Publications Relative to a Number of FTE
SCMR Second Capital Market Reform
SCOM Communal Services Sector
SENCE Chile's Servicio Nacional de Capacitación
y Empleo
SFIN Financial Services Sector
SIMCE System of the National Performance Evaluation
for Education Establishments
SINTEF Norway's Foundation for Scientific
and Industrial Research
SME Small and Medium Entreprise
SNED Skills-renewal and financial assistance
TEKES National Technology Agency of Finland
TFP Total Factor Productivity
TIMSS Third International Mathematics and
Science Study
TRAN Transportation and Communications Sector
UNCITRAL United Nations Commission on International
Trade Law
WB World Bank
UK United Kingdom
US United States
USD United States Dollar
VARX Vector Autoregressive Model with
Exogenous Variables
VAT Value Added Tax
VTT Technical Research Center of Finland
Vice President: Pamela Cox
Country Director: Axel van Trotsenburg
Sector Director: Ernesto May
Sector Manager: Mauricio Carrizosa
Task Managers: Daniel Oks and James Parks
Acknowledgements 6
Preface 7
Executive Summary 9
Development policy review 13
a. Strategic setting of DPR 13
b. Growth and poverty outcomes: development challenges 13
c. Promoting sustainable productivity growth 16
Business Environment and Enterprise Dynamism 16
Sustaining Dynamism 17
Improving Access to Credit 17
Strengthening Competition 19
d. Innovation 21
Does Chile Have an Innovation Problem? 21
What is Meant By Innovation and what are the Aspects of Innovation in which the Country Exhibits Weaknesses? 21
What Does Recent Experience and the Literature Suggest for Principles and Broad Policy Measures to Foster Innovation? 23
Government Sponsored Innovation Related Tasks 24
Private Sector Led Innovation Related Tasks 25
Other Barriers to Innovation: An Open Research Agenda 25
e. Education 25
Investment in Education 26
Access to Schooling and Inequality 26
Higher Education Expansion, Quality and Equity 26
The Quality of Primary and Secondary Education 27
The Education Market in Chile 28
The Role of the State in Ensuring Quality and Equality of Educational Opportunity 29
Supporting the Evaluation of Education Policies and Programs 30
f. Enhancing social protection 31
The Main Risks to Household Income Security, Outcomes, and Remaining Challenges in Social Protection 32
Covering the Risks to Income that Arise with Ageing 35
Summary of Key Policy Options for Social Protection 36
g. Public finance issues in development 37
Public Expenditure - Development Needs 37
Tab
le o
f C
on
ten
ts
Public Expenditure and Economic growth 39
Financing Development - Taxes 39
The Tax System 40
Tax Avoidance and Evasion 40
Policy Options to Lower Tax Evasion and to Improve Efficiency and Equity 41
Financing Development - Fiscal Rule 42
h. Risks to convergence with advanced economies 43
Sources of Vulnerability 43
Reducing vulnerability: International risk-diversification through the financial system 44
Conclusions 47
Agenda for Future Research 48
Summary of Policy Options 49
Matrix: remaining challenges and policy options 51
References 54
List of Tables 1111
Table 1. Cost of Starting and Closing a Firm, Job Security and Cost of Hiring and Firing Workers 18
Table 2. Creditor Rights, Rule of Law, Days Needed to Enforce a Contract, Days to Collect a Bounced Check,
Effective Creditor Rights, and Volatility of Credit 20
Table 3. Chile's educational performance is low when compared to the OECD 28
Table 4. SIMCE 8th Grade Test Results, 2004 30
List of Figures 1111
Figure 1: Chile GDP per capita Growth, 1990-2004 (percent) 14
Figure 2: Official Poverty Lines (National): Chile, 1990-2003 (percent) 15
Figure 3: Active population, employment and unemployment rate, 1990-2004 15
Figure 4. Stocks and Flows of Credit to the Private Sector (Million of Real Pesos) 19
Figure 5. Recipes for Development- Innovation Related Investments, Conditional on GDP/Capita 22
Figure 6. Innovation Expenditures as % of Sales 23
Figure 7. Education expenditures: Chile, LAC and OECD 26
Figure 8. Years of schooling by income decile for population aged 25 years or more 27
Figure 9. Minimum cost of labor in Chile and OECD countries 33
Figure 10. Real Expenditures: 1990-2003 37
Figure 11. Targeting of Social Expenditures: Shares of Public Subsidies Received 38
Figure 12. Tax Ratio vs. GDP per capita 41
Figure 13. Effective Average Tax Rates with and without Credits, Deductions 42
Figure 14. Real Copper Prices and GDP growth, 1960-2004 44
A c k n o w l e d g e m e n t s
The Development Policy Review (DPR) was co-managed by Daniel Oks (Lead Economist, LCSPR) and JamesParks (Sector Leader and Lead Economist, LCSPR). Daniel Oks and Frank Earwaker (consultant) puttogether Volume 1. Emily Sinnott (LCC7A) put together Volume 2 based on contributions from a team ofBank staff and consultants following missions held during the second half of 2004. It draws upondiscussions with a wide range of individuals in Government, think tanks, academia, consultants, andinternational organizations. It also draws upon material presented by experts at two workshops held inSantiago de Chile during November-December 2004. A list of the team members who wrote or contributedto the various chapters in Volume 2 follows below:
Chapter 1: Development Challenges. Emily Sinnott (LCC7A)Chapter 2: Promoting Sustainable Productivity Growth. Sara Calvo (LCSPE)Background papers: Alejandro Micco (IDB) and Alex Galetovic (consultant)Chapter 3: Innovation. William Maloney (LCRCE), Kristian Thorn (LCSHE), Andres Rodriguez (IDB) andAndres Zahler (consultant)Chapter 4: Education. Emiliana Vegas (LCSHE) and Alejandra Mizala (Universidad de Chile)Chapter 5: Social Protection. Truman Packard (LCSHD)Chapter 6: Public Finance Issues in Development. Daniel Oks (LCSPR)Staff: Alvaro Vivanco (LCSPE)Background papers: Alvaro Vivanco (LCSPE), Claudio Agostini, FrancescoGiavazzi, Roberto Perotti (consultants)Chapter 7: Risks to Convergence. Emily Sinnott (LCC7A) and James Parks (LCSPR)Background paper: Alvaro Vivanco (LCSPE)
The team would like to thank various Government officials including the Finance Minister - Mr. NicolasEyzaguirre - and the Budget Director - Mr. Mario Marcel - for their cooperation and assistance inidentifying the agenda and obtaining the information. Sara Calvo (LCSPE) and Mr. Luis Escobar (Directorat Ministry of Finance) led the organization of the workshops in Santiago. Valuable suggestions andsupport were received from Axel van Trotsenburg (LCC7C Director), Jesko Hentschel (Sector Leader LCSHD),Carter Brandon (Sector Leader, LCSES). The report also benefited from the able assistance of MaritzaBojorge (LCC7A) and Maria Estrella (LCC7A).
P r e f a c e
The Chile Development Policy Review (DPR) covers economic developments in the country through early2005. The Summary Report was sent to the previous Government in September 2005 and the Main Report(volume 2) was submitted to the new Government in March 2006. Following consultations with theGovernment in June 2006, it was agreed to proceed with circulation of the report to the Board in grey coverin the present form. In addition, it was agreed to organize a seminar in Chile to disseminate the report.The DPR complements the Policy Notes presented to the new administration in March 2006.
Since the DPR was communicated to the authorities, the new Government, which took office in March2006, has launched its development strategy. The new strategy reiterates Chile's commitment to thepursuit of prudent macroeconomic management, further development of market institutions, innovationand strengthening of social policies and education. The new Government has strengthened the focus onenhancing equality of opportunity through education, pension reform and child development. It hasappointed a Pension Commission, an Education Commission and a Child Development Commission, allcharged with preparing policy proposals in consultation with stakeholders, including civil society. TheGovernment has also moved to create an Innovation Council with representatives of 5 ministries and non-government stakeholders. All these areas - social security, education and innovation - are at the core ofthe DPR and the new Government's policies are fully consistent with the options presented in the report.The other key areas covered by the report - investment climate, labor markets, taxation and publicfinances - are also important elements of the new Government's strategy. Therefore, the themes andpolicy options discussed in the DPR remain relevant for Chile today.
Since the new Government has taken office, the main economic developments that have emerged are thefurther accumulation of fiscal surpluses stemming from copper-related revenues and growing demandsfor social expenditure. The Government has committed to continued full compliance with the fiscal ruleand has prepared proposals to invest copper surpluses (in a pension fund that will cover State pensionliabilities, in central bank recapitalization and in a Fund for Economic and Social Stability). Managing thecopper surpluses and assessing the effectiveness and fiscal impact of new public spending initiatives willbe key challenges for the Government.
E x e c u t i v e s u m m a r y
As the fastest growing economy in the region
during 1990-2004, Chile has become a benchmark
for reform in the LAC region. There is consensus in
Chile on the need for a new round of reforms to
foster a more knowledge-based economy that will
ensure the continuation of high and equitable
growth. The aim is to achieve convergence with the
lower tier of advanced economies by 2020. At the
same time, the Government wants to reduce
poverty which, although cut in half over the last 15
years, is still a high 18 percent. Poverty reduction
will be the key to improving the distribution of
income which is currently one of the most unequal
in the world.
The Development Policy Review (DPR) examines
policy options that could help Chile to achieve the
twin goals of fast and equitable growth. Rather
than attempting a comprehensive coverage, the
report focuses selectively on areas with the greatest
potential impact on growth and equity. The
proposed strategy aims, on one hand, to enhance
the investment climate for fast knowledge-based
growth and, on the other, to improve equity
through better social protection and education. To
enhance the investment climate, “micro- flexibility”
can be enhanced, which is to say eliminating
obstacles to the reallocation of resources and
factors of production at the enterprise level. At the
same time, innovation policies can be strengthened
and fiscal incentives can be refined. To improve
equity, options are proposed to cushion the poor
from adverse shocks-such as job loss, costly
treatment of injury or sickness, and the loss of
income associated with old age-as well as deeper
education reforms to ensure access to high quality
education, especially for the poor. An agenda for
reform is proposed along the following lines:
(a) Promoting Sustainable Productivity Growth.
It is imperative for Chile to reduce obstacles that
impede a fast adjustment to shocks. While Chile
has a favorable investment climate relative to
m a n y o t h e r c o u n t r i e s a n d h a s d o n e w e l l i n
e s t a b l i s h i n g g e n e r a l l y a d e q u a t e c o m p e t i t i o n
policies, there remain obstacles that, i f reduced
or removed, wi l l lead to further increases in
p r o d u c t i v i t y a n d m a k e t h e e c o n o m y m o r e
r e s i l i e n t t o s h o c k s . T h e r e p o r t r e c o m m e n d s :
s t r e n g t h e n i n g t h e e n f o r c e m e n t o f c r e d i t o r
rights; improving the efficiency of bankruptcy
p r o c e e d i n g s ; r e s t r u c t u r i n g j o b s e c u r i t y ; a n d
decreasing wage rigidity by further de-indexing
w a g e s . T h e r e p o r t a l s o r e c o m m e n d s ( i )
strategies to promote access to credit by small
9
and medium enterprises; and (i i) strengthening
institutions that guarantee competition.
(b) Innovation. Innovation is crucial for
sustaining growth in a knowledge-based economy.
Compared to the OECD, Chile lags substantially in
Research and Development (R&D) expenditure;
private sector participation in R&D; patenting and
in the relative importance of applied, as opposed to
basic, research. Like Spain and Italy, Chile has
relied heavily on FDI and has a large number of
successful firms that focus on innovation in both
production and management. There is a
considerable potential for further TFP growth
unrelated to R&D. Nevertheless, investment in
Science and Technology (S&T) and R&D is important
over the medium and long term. Increasing S&T
capability requires more than increasing the
number of research units and well trained workers.
It also requires improving the diffusion of
knowledge, and that in turn implies viewing the
National Innovation System (NIS) as a network to
facilitate the transmission of knowledge. The
actual structure of the NIS may be less important
than incentives within institutions and well
designed links between them.
(c) Education. Education is critical for achieving
high and sustained growth in a knowledge-based
economy and for improving equity. The
educational reforms begun in 1990 resulted in a
significant increase of investment in education and
they also led to a substantial expansion in the
coverage and quality of education. However, there
remain problems of access that negatively affect
quality and equity in the education system.
Differences between subsidized private and
municipal schools have impeded the creation of an
“education market” that would improve
educational efficiency and quality. The Government
can help by supervising and encouraging schools to
achieve desired results; ensuring equality of
educational opportunity through well targeted
subsidies; improving the information available to
parents and civil society on school quality;
attracting and retaining qualified teachers;
creating a more level playing field between
subsidized private and municipal schools in terms
of admissions; and conducting regular evaluations
of education policies and programs.
(d) Social Protection. While education can go a
long way toward creating equal opportunities, it
cannot dispel the risks to welfare that affect the
most vulnerable segments of society. Many
households remain vulnerable to poverty from
adverse income shocks such as job loss, costly
treatment of injury or sickness, and the losses to
income associated with old age. Extending the
coverage of social protection to a greater number
of the most vulnerable without creating moral
hazard and dependence while, at the same time,
fostering opportunity and enterprise continues to
be the over-arching challenge for policy makers.
Some specific recommendations for enhancing
social assistance include a complete and rigorous
evaluation of Chile Solidario (specially its failure
to achieve the goal of stable income and
employment); assessing the impact of the
minimum wage on employment opportunities for
the poorest; and evaluating the possible financing
of Plan Auge from general-taxation. Improvements
to household welfare from reforms to the second
and third pillar of the pension system could be
10
enhanced by consolidating and strengthening
instruments for preventing poverty in old age.
(e) Public Finance Issues for Development. Over
the medium and long term, Chile is likely to
experience pressures on Government expenditures
stemming from demographic factors, social needs
and new public goods. The efficiency and equity of
the tax system can be improved while
simultaneously reducing tax avoidance. Numerous
income tax credits, deductions and exemptions
which benefit the relatively better-off and which
unnecessarily complicate tax administration could
be eliminated. A reduction of the withholding tax
on dividends of foreign corporations would also
reduce tax avoidance while having a positive net
effect on FDI. The reduction or elimination of VAT
exemptions and special regimes (e.g., construction)
could boost revenue while simplifying tax
collection. There are also opportunities to refine
the fiscal rule so as to increase its anti-cyclical
effect and stabilize the seasonal impact of fiscal
policy. Over the longer term, once a firm basis for
fiscal policy has been consolidated, the
Government could consider adopting a rule
whereby the ratio of debt/GDP would eventually
converge to the ratio of public-capital-stock/GDP.
That would avert an undue reduction of the public
debt which may cause public investment to be
deferred even when the rate of social return is high.
At the same time, the anti-cyclical features of the
fiscal rule would be preserved.
(f ) Risks to convergence to advanced
economies. Being a small open economy, Chile
remains vulnerable to regional and global
developments, and to shifts in demand from its
major trading partners. A slump in the demand for
primary products such as copper or fluctuations in
capital flows would substantially reduce short-term
growth prospects. In the past 100 years, most major
fluctuations in output were caused by adverse
external shocks. In particular, there is a close
correlation between output growth and the price of
copper. This represents a significant risk for Chile,
since prices are currently at extremely high levels.
External risks remain important even though the
country has diversified towards non-traditional
exports - which have doubled as a share of exports
since 1970 - and has greatly enhanced its
macroeconomic framework with a low public debt,
a well regulated and deep financial sector and a
market-driven exchange rate. A continued
emphasis on increasing the dynamism of the
private sector, deepening global integration and
diversifying economic activity will help to reduce
this vulnerability still further. There is also room to
reduce vulnerability through international capital
markets. The cross-border transfer of real and
financial assets is an alternative. For example,
relaxing the restrictions on pension funds by
allowing them to invest abroad has already helped
to diversify risk. Over-the-counter derivatives such
as equity swaps are another option that merits
consideration.
11
D e v e l o p m e n t p o l i c y r e v i e w
a . S t r a t e g i c s e t t i n g o f D P R
1. The development policy review (DPR) seeks (i) to present a
broad overview of the development challenges facing Chile,
and (ii) to address selected issues of importance in attaining
the goal of high growth with equity. It includes in-depth
coverage of private sector development; innovation;
education; social protection, and public finance. The DPR is
intended to contribute to the dialogue on overall policy and
institutional priorities.The report is prepared at the request of
the Chilean authorities.The focal areas of the report emerged
from consultations with the Government; including a
preparatory brainstorming session with the Ministry of
Finance in mid-2004 and two workshops held in Chile in
November and December 2004.
2. The report aims to present a clear picture of Chile's
development challenges and policy options to address them.
The DPR concentrates on a few selected areas which the
Government, the Bank and many stakeholders believe are
crucial to the country's growth and social agendas. Many
other areas that are also key to sustained growth -- like trade,
financial markets and infrastructure -- in which Chile has
already made important advances have been left out of the
report. The report also identifies priority areas for future
research where important knowledge gaps exist - e.g. female
participation in labor markets, pre-school education, regional
decentralization and informality. The DPR is an important
tool for guiding the future policy dialogue between Chile and
the World Bank. It covers many key areas of the Bank-
supported program in Chile and will be a key analytical input
into the forthcoming country assistance strategy (CAS).
3. The DPR is composed of a summary report (Volume 1) and
a main report (Volume 2) which comprises a more detailed
analysis of sector issues. Volume 1 is organized as follows:
Section B reviews growth and poverty outcomes and
challenges; Section C discusses policy options to foster a
dynamic enterprise sector; Section D proposes strategies for
strengthening innovation; Section E discusses options for
deepening education reform and improving equality of
access to quality education; Section F proposes options to
enhance social protection; Section G proposes tax and fiscal
measures to finance future development needs; and Section
H concludes with a discussion of risks associated with
convergence to high per capita income countries, a summary
of recommendations and a proposed research agenda.
b . G r o w t h a n d p o v e r t y o u t c o m e s :d e v e l o p m e n t c h a l l e n g e s
4. Chile has become a benchmark for reform in the LAC region.With an average annual per capita growth rate of 4.1 percent,
it was the fastest growing economy in Latin America from
1990 to 2004 (Figure 1). Chile has doubled its income since
1990, reducing the gap between its per capita income and
that of high-income OECD economies. Chile's growth
performance, while assisted by favorable external conditions,
owes much to a strong institutional framework built on
structural reforms put in place since the 1970s, solid fiscal
fundamentals, prudent monetary policies, deep integration
into the global economy, and the development of a solid and
deep financial sector. Economic stability is reflected in single-
digit inflation, a structural fiscal surplus, low public debt,
sovereign spreads equal to those of advanced economies,
and a high degree of financial sector stability.
5. The slowdown in growth over the recent past associated withthe Asia/Russia/Brazil crises illustrates the continued vulnerabilityof Chile - a small open economy - to external conditions.1 During
1998-2003, GDP per capita grew at an average of 1.3 percent
per annum, far below the rate experienced in the previous 10-
13
1. However, macroeconomic policy inconsistencies - in particular, defending a target exchange rate through unsustainably high interest rates - have also played arole in the 1998-99 slowdown.
year period. Yet, Chile was able to withstand the shocks of the
late 1990s far better than many other countries in the LAC
region. It was the only country in LAC to reduce the gap
between its GDP per capita and that of advanced economies.
In addition, the decline in growth resulting from adverse
external shocks was far less severe than in the past, showing
the increased resilience of the Chilean economy. Structural
reforms, the continuity of sound economic policies and good
institutions go a long way toward explaining this performance.
6. The slowdown also shows the importance of efforts to furtherenhance the macroeconomic and microeconomic frameworkand reduce the vulnerability to shocks. The Government has
introduced a number of macroeconomic measures since
1999 designed to consolidate credibility and stability. These
include the adoption of a free-floating exchange rate regime,
the institution of an explicit fiscal policy rule, the move to a
purer form of inflation-targeting, and a deepening of the
foreign exchange derivatives market. In spite of substantial
progress on the macroeconomic front, much remains to be
done to address microeconomic rigidities and to foster
institutional capacities. Recent evidence suggests that
microeconomic inflexibilities that impair the reallocation of
resources and factors at the level of the firm have prolonged
adjustment to the shocks of the late 1990s.
7. Achieving fast and sustained growth in Chile will involveimproving education and enhancing the adoption ofinnovation/technology. There is consensus on the importance
of a new round of reforms to move toward a more
knowledge-based economy that will ensure high growth and
convergence towards the advanced economies. The aim for
Chile is to achieve convergence with the lower tier of
advanced economies by 2020. Meeting this objective will
require fast and sustained growth. A growth rate of 5 percent
per annum will bring Chile's GDP per capita to the present
level of Spain by 2023. Chile is faced with the challenge of
following the example of successful resource-rich countries
like Australia, Finland and Sweden and becoming a more
knowledge-based economy. An environment that is deficient
in human capital and innovation would slow or impede
income convergence with advanced economies.
8. Considerable gains have been made in the fight againstpoverty. Strong growth, coupled with well-targeted social
policies, led to a sharp drop in poverty. Since the return to
democracy,poverty levels have more than halved to around 18
percent in 2004 (Figure 2). Chile now has the second lowest
headcount poverty rate in the LAC region, after Uruguay.Social
indicators, including enrollment in primary education, youth
literacy, infant mortality and life expectancy have also
improved, reaching levels close to advanced economies.
9. The integration of the poor into the labor market was a majorfactor that contributed to a reduction in poverty. Between 1990
and 2003, the total number of people active in the labor
market increased by 29 percent, from 4,824 thousand to
6,199 thousand (Figure 3). The rise in participation was due in
large part to the incorporation of unskilled and semi-skilled
women into urban labor markets. The gap between the
participation rate of the well-educated and the poorly-
educated fell substantially over the 1990s, as the unskilled
became increasingly active in the labor market. Over the
same time period, employment increased by 27 percent, from
4,450 thousand to 5,653 thousand.
10. Despite progress, almost one in five of the populationremains poor. Households with incomes close to the poverty
line remain vulnerable. This vulnerability can be acute when
members of households become unemployed, particularly if
they were self-employed or had jobs in the informal sector.
For the informal or self-employed worker, there remain
institutional barriers to even the most basic forms of social
protection.
14
Source: World Bank, Development Data Platform and staff estimates.
90
Chile
1210
86420
-2-4 91 92 93 94 95 96 97 98 99 00 01 02 03 04
ALC average
11. Chile also faces a formidable challenge in terms of reducinghigh levels of inequality, especially inequality of opportunity.The distribution of income in Chile is highly skewed, with a
Gini coefficient close to the most inequitable countries in
Latin America and Africa.The only country with a higher level
of inequality and a higher level of income is South Africa.
Reducing inequality remains a substantial challenge for both
the Government and society. Increasing equality of
opportunity and the number of highly-educated individuals
in the labor force will be key to reaching the high income
levels of advanced economies.
12. Income inequality is mirrored by inequality in educationalattainment across the different socioeconomic classes in Chile.Those in the top quintile of income earners have twice the
number of years of education than do the bottom quintile.
Therefore, improving access to quality education and
increasing the participation of the poor in adult training
programs is an important means of addressing inequality.
One key factor underlying inequality and poverty is the low
rate of female participation in the labor force. Low female
participation deprives households of a valuable opportunity
to raise income and overcome poverty. The low rate of female
participation is partly explained by an under-developed
system of pre-school education. Pre-school education not
only facilitates access to jobs for women, but it also ensures a
more level playing field in terms of access to education and
educational performance. The 2006 World Development
Report cites evidence that pre-school education is a good
investment with a high rate of return.2
13. In sum, the twin challenge for Chile is to achieve high andequitable growth. The strategy outlined in this report is based
on policy options that fall under two broadly defined pillars.
An investment pillar which comprises policies and reforms to
improve conditions for investment in physical and human
capital; and a social pillar which includes policies and reforms
aimed at reducing inequality and strengthening social
protection. Policies in the investment pillar include: (i)
measures to improve allocative efficiency by reforming labor
market regulations, improving access to credit, and
strengthening competition, (ii) measures to improve TPF by
15
Source: MIDEPLAN, Encuesta CASEN (1990, 1992, 1994, 1996, 1998, 2000 and 2003). Poor and Indigent Indigent
40353025201510
50
1990 1992 1994 1996 1998 2000 2003
Notes: Includes active share of total population over 15. Source: INE, Chile.
Employed (1hs)
Labor force (1hs)
Unemployed (inverted rhs)
6.500
6.000
5.500
5.000
4.500
4.000
Tho
usa
nd
s
Tho
usa
nd
s
0
100
200
300
400
500
600
1990 1992 1994 1996 1998 2000 2002 2004
2. The return per dollar invested in pre-school education is well above the opportunity cost of capital. See World Bank (2005b), Figure 7.2 (page 133).
encouraging innovation and enhancing education, (iii) fiscal
reforms to improve equity and efficiency in the tax system
and to improve conditions for investment in general, and (iv)
measures to reduce or eliminate micro-rigidities -
strengthening creditor rights, bankruptcy procedures - that
slow-down adjustment to shocks. Policies in the social pillar
include: (i) guaranteeing that all children have access to
education of an adequate quality and that the education
system does not discriminate against opportunities of low
income population; and (ii) reducing vulnerability to poverty
from adverse income shocks such as job loss, costly
treatments for injury or sickness, and the loss of income
associated with old age.
c . Promoting susta inable produc t iv i t y growth
14. For Chile to succeed in converging with the lower tier of
advanced economies by 2020, a key challenge is to eliminate
the institutional and policy obstacles that prevent enterprises
from adjusting rapidly to economic shocks. More generally,
improving Chile's competition policies and institutions will
contribute to sustainable growth in productivity and GDP.
Chile has done well in establishing generally adequate
competition policies, and it ranks on a level with developed
countries. Some recent studies point to current labor policies
and difficult access to credit - among other factors3- as
contributing to the loss of dynamism of firms after the shocks
of the 1990s. A recent World Bank Investment Climate Survey
of firms of all sizes and in all sectors, revealed that about 25
percent of firms believe that labor regulations, access to
finance, and anti-competitive practices severely limit the
expansion of their enterprise.
15. This section examines three issues. First, the dynamism of
Chilean firms as a contributor to higher factor productivity
through the efficient allocation of factors of production.
Second, the importance of sustaining corporate dynamism
through lower exit costs, increased labor market flexibility
and enhanced access to credit. Third, the challenge to
strengthen competition policies and remove restrictive
regulations in order to foster greater competition.
Business Environment and Enterprise Dynamism 16. Recent studies highlight the importance of a dynamic
process of market entry and exit in order that enterprises may
contribute to growth and job creation in industrial and
developing countries alike. As new firms enter and less
efficient ones leave the market, there is a reallocation of factors
which results in higher factor productivity. In the case of the
manufacturing sector, 50 percent of total factor productivity
growth of the last decade is explained by reallocation of
factors from low-productivity firms to high-productivity firms.
The key is having in place a business environment or
investment climate that facilitates the process of entry and exit
of firms and an efficient reallocation of factors of production.
17. Chile has a favorable business environment relative to manyother countries and there is significant enterprise dynamism.Government policies and institutional reforms provide a
secure macroeconomic policy environment and a stable
financial sector. In addition, the cost of doing business is
relatively low as a result of privatization, market liberalization
and a competitive environment. As a result, the process of
market entry and exit has been easy and labor turnover has
been rapid, ranking on a level with OECD economies. On
average, there is a turnover of one of every four jobs each year.
The entry-exit process is mainly concentrated in small and
medium-sized firms. The market behavior and productivity of
enterprises, both large and small, is diverse and that augurs
well for further productivity gains under an improved business
environment that could promote even greater dynamism.
18. The process of entry and exit and job reallocation sloweddown after the shocks of the late 1990s. Since then, small
manufacturing firms have exhibited a lower net rate of entry-
exit and a lower growth in employment and sales than have
larger firms. These findings are consistent with the loss of
microeconomic flexibility of manufacturing firms observed
since the late 1990s by Caballero, Engel and Micco (2004). A
flexible economy is one in which actual employment can be
quickly adjusted to the desired level. In Chile, it takes
manufacturing firms a year to adjust their actual payroll to
within 72 percent of the desired level. That indicates that
microeconomic flexibility in Chile is higher than in Brazil and
Mexico, but lower than in the US where the full adjustment
can be completed within one year. The speed of adjustment
of small and medium-sized firms (SMEs) dropped
significantly after the shocks of the late 1990s. These results
are consistent with the view that labor regulations and credit
constraints - which may have become more binding in the
late 1990s - have slowed the adjustment of SMEs. 4
16
3. For example, macroeconomic policy inconsistencies - targeting the exchange target through unsustainably high interest rates in a fiscally expansionary context- played an important role as well.4. Flexibility didn't drop in the case of small and medium-sized firms with small employment gaps or of large firms with large or small employment gaps. For smallgaps, internal resources may suffice to fund adjustment. Larger firms tend to be better positioned to finance labor mobility - their access to bank credit did not suf-fer as much during the late 1990s as in the case of small firms.
Sustaining Dynamism19. The reduction of microeconomic flexibility after the shocks ofthe late 1990s points to difficulties such as the cost of closing ofa firm and enforcing creditor rights as well as obstacles thatrestrict the mobility of labor and financial resources betweenfirms. Reducing obstacles to microeconomic flexibility for
small and medium-sized firms is particularly important
because those firms account for a large part of total
employment and they could play a key role in fostering the
overall dynamism of the productive sector.
Lowering Exit Costs20. Closing a business remains costly. International rankings
point to the high cost of closing a business in Chile relative to
other industrial and emerging economies - Table 1. Exit costs
are elevated because of complex bankruptcy procedures and
poor enforcement of creditor rights. As discussed in the
recent World Bank Report on Observance and Standards &
Codes (2004b), under the bankruptcy law, an enterprise may
be reorganized under judicial proceedings, but creditors are
not given voting rights, in contrast to modern bankruptcy
laws. Moreover, the current law does not take account of the
business needs of the debtor during reorganization, making
it more difficult for a firm to remain afloat during the
transition. Judicial proceedings to collect defaulted loans are
also lengthy and costly.
21. The Second Capital Market Reform Bill, (SCMR), submitted toCongress last year, would address some of the problems. The
proposed legislation would (i) create a Unified Registry for all
movable assets pledged as collateral, as well as other
information pertinent to lenders;and (ii) introduce modern rules
to deal with the off-set and netting-out of financial contracts
under insolvency proceedings including provisions to clarify the
treatment of subordination debt agreements in bankruptcy.
Facilitating the Reallocation of Labor22. Labor markets in Chile are flexible, ranking better thanindustrial and emerging economies alike. However, the costs offiring workers (i.e., the cost of required advance notice,severance payments and penalties due when dismissing aredundant worker expressed in weekly wages) is relatively large- Table1. Recent studies reveal that measures to enhance job
security resulted in a loss of labor flexibility following the
shocks of the late 1990s. The provisions for job security
increase the cost of reducing a pay-roll and therefore lead to
fewer dismissals when firms face negative shocks. Conversely,
when they experience a positive market boost, the
employment response is smaller because firms take into
account that workers may have to be fired in the future.
According to one recent study, if Chile were to adopt the level
of job security of New Zealand, it would increase the speed of
employment adjustment by 14 percentage points and
accelerate growth by 0.3 percentage points - Micco (2005).
23. The problems engendered by the framework of job security inChile may impair labor mobility and increase administrativecosts (Box 1). For example, the judicial process which settles
disputes between employees and employers is extremely
slow in Chile and, hence, it increases the administrative costs
of the system. Gazmuri (2004) shows that labor disputes take
around 250 days to be settled in Chile. If one party appeals,
the process can last an additional 230 days. A recent study
based on a sample of 60 countries during the period 1980-
1998 found that industrial employment adjusts at a slower
pace in countries with high legal protection against dismissal,
especially when such protection is likely to be enforced
(Caballero, Cowan, Engel and Micco, 2004).
24. In Chile the minimum wage and wage indexation becameincreasingly binding constraints following the shocks of the late1990s (Box 1). A high minimum wage and wage indexation
prevent the downward adjustment of nominal wages and
that leads to the dismissal of employees if a firm needs to
retrench. Chile's statutory minimum wage increased in the
late 1990s. As a result, the minimum wage doubled to around
60 percent of the market wage for unskilled workers between
December 1997 and December 2002, putting more pressure
on the wage bill of SMEs and thereby discouraging
employment. That could partly explain the slow growth of
employment in small firms after 1998. Those firms have a
higher proportion of unskilled labor and, therefore, of low-
waged workers than larger establishments. A binding
minimum wage therefore affects them more.
25. Reducing the severance-payment component and
increasing the employment insurance component of job
security and in general reducing wage rigidities will
contribute to a faster adjustment to shocks.
Improving Access to Credit 26. The stock of bank credit to the private sector stagnated in1998-2000 (Figure 4) with large firms crowding out credit tosmaller firms. Chile has a well-functioning financial sector
that compares favorably with other countries at a similar level
of development. Competition in the banking sector has
increased in recent years as new entrants, including foreign
banks, have joined the sector and as capital markets have
further deepened. This has contributed to sustained
increases in bank credit, particularly for larger firms which
also have better access to foreign credit and local capital
markets. As highlighted in the IMF-World Bank Financial
17
Sector Stability Assessment (IMF 2004), competition has not
significantly improved access to credit by small and medium
firms. Restricted access to credit by smaller firms is not an
exclusively Chilean phenomenon. In fact the shortfall is lower
in Chile than in Brazil, Hungary or Slovenia. Nevertheless,
after the shocks of the 1990s small and medium firms in Chile
faced tighter credit markets and credit constraints became
more binding, forcing them to exit the market more for
reasons of liquidity than of profitability.
27. The sudden reduction in credit to small and medium firms inthe late 1990s may be explained by the likely increase in riskaversion of banks which privileged the lower risk profile of largefirms. Under those circumstances, smaller firms found it moredifficult to roll over credit. In Chile, bank loans account for
around 20 percent of short-term financing for all firms. It is
typically used for working capital. The higher cost of credit
for SMEs relative to large firms is the result of their higher
credit risk and the higher monitoring cost for creditors. High
credit risk stems in part from the poor enforcement of
creditor rights. While Chile fares better than other Latin
American economies in enforcing creditor rights, it still falls
behind countries like Australia, Korea and New Zealand.These
countries have been able to weather crises more successfully
than Chile, and they have faced a less volatile market for
credit (Table 2). Improved enforcement of creditor rights will
afford smaller firms a more secure access to credit.
28. The continued development of the financial sector will helpto improve access to credit for smaller firms. Specific
recommendations to further develop the financial sector
include: (i) broadening and diversifying investment
opportunities for private pension funds; (ii) filling gaps in
market structure to improve liquidity; and (iii) adapting the
supervisory framework to meet the needs of an increasingly
integrated and complex financial system. Banks have recently
18
Table 1. Cost of Starting and Closing a Firm, Job Security and Cost of Hiring and Firing Workers
Chile 10.0 0.31 0.81 0.29 5.6 18 19.3Australia 2.1 0.14 0.53 0.14 1.0 8 80.0Canada 1.0 n.a. n.a. n.a. 0.8 4 89.1Finland 1.2 n.a. n.a. n.a. 0.9 1 90.2Ireland 10.3 n.a. n.a. n.a. 0.4 8 88.9New Zealand 0.2 0.04 0.00 0.14 2.0 4 71.4Spain 16.5 n.a. n.a. n.a. 1.0 8 83.4South Korea 17.7 0.26 0.62 0.29 1.5 4 81.1USA 0.6 0.08 0.07 0.14 3.0 8 68.2OECD 8.0** 0.33 0.41 0.46 1.6** 6.8** 72.2**Latin America & Caribbean 60.4 0.50 0.5 0.36 3.6 15.8 26.6East Asia & Pacific 48.3 0.26 0.52 0.24 3.4 29.8 30.4South Asia 45.4 n.a. n.a. n.a. 5.2 8.3 21.4
** High income country.
DEFINITIONS: Job Security: the average of (i) protection of grounds of dismissal; (ii) protection of dismissal procedures; (iii) notice and severance payment; and (iv) right to job security in theconstitution. It ranges from zero to one. Cost of firing workers: the cost of firing 20 percent of the firm's workers (assuming that 10 percent are fired for redundancy and 10 percent without cause). Costis defined as the sum of the notice period, severance pay, and any mandatory penalties established by law or mandatory collective agreements for a worker with three years of tenure with the firm. Ifdismissal is illegal, this cost is the annual wage. The new wage bill incorporates the normal wage of the remaining workers and the cost of firing workers. The cost is the ratio of the new wage bill to theold one. Dismissal procedures measures worker protection granted by law or by mandatory collective agreements against dismissal. It is the average of the following seven dummy variables which equalone: the employer (1) notifies a third party before dismissing more than one worker; (2) needs the approval of a third party prior to dismissing more than one worker; (3) must notify a third party beforedismissing one redundant worker; (4) needs the approval of a third party to dismiss one redundant worker; (5) must provide relocation or retraining alternatives for redundant employees prior todismissal; and (6) priority rules applying to dismissal or layoffs, and (7) priority rules applying to reemployment. Index: 0: low; 1: high.
Sources: Doing Business (World Bank, 2005), Botero, La Porta, Lopez-de-Silanes and Shleifer 2003.
Cost ofStarting a
Business (% GNIper capita)
(Botero et al,2003)
Job SecurityIndex
Cost of FiringWorkers
Index
(Botero et al, 2004) Closing a Business
DismissalProcedures
Index
Time to complete
closure (years)
Cost of bankruptcy proceedings (% of estate)
Recovery rate(cents on the
dollar)
19
Box 1. Job Security, Minimum Wage, and Wage Indexation
Job security. Chile's regulatory provisions governing job security consist of severance payments and a type of unemployment insurance. Severance paymentshave been the traditional legal mechanism to protect employees because they are easy to implement. However, severance pay is inefficient as an insurancemechanism and it distorts hiring and firing decisions. Severance payments account for more than 80 percent of all benefits. Furthermore, unemploymentinsurance is also inefficient as an insurance mechanism and generates problems of moral hazard.
Minimum wage. The minimum wage has increased since the late 1990s. In May 1998 Congress decided to increase the minimum wage by 12.7 percent inJune, 1998, 12.4 percent in June, 1999, and 10.5 percent in 2000, moving towards a minimum monthly wage target of 100,000 pesos by the year 2000. Thispolicy entered into effect just before growth decelerated in the third quarter of 1998, and when growth was still projected at over 6 percent per year.aAround 6 percent of Chilean workers were affected by the minimum wage hike that took place between 1997 and 2000 (Cowan et al, 2004) based on datafrom the Chilean employment survey. A further 12 percent increase took place on July 1, 2005.
Wage indexation. Information about indexed wage contracts is limited but, reportedly, wage indexation has decreased in recent years. Collective bargaininghas led to wage contracts extending over a period of two years on average. They include provision for full backward indexation to inflation every six months,and they have not changed significantly over the last 15 years, despite falling inflation. In the manufacturing sector coverage amounts to 35 percent of totalsector employees.
a See Cowan and Micco (2005) and Cowan et al (2004) for a discussion on the rationale of this measure.
Source: Banco Central de Chile Stocks: line, right axis Flows: bars, leftaxis
353025201510
50
-5-10-15
300
250
200
150
100
50
091 92 93 94 96 9795 98 99 00 02 0301 04
increased their lending to small and medium firms through
leasing. Measures such as unifying the legislation on movable
collateral and creating a single registry for pledges will
further foster bank lending.
29. The Government may also consider specific actions tofacilitate access to credit by small and medium-sized enterprises.As proposed in the World Bank - A Strategy to Promote
Innovative Small and Medium Enterprises (2004c) - the
following actions may be considered: (i) a feasibility study of
market driven schemes including mutual guarantee
associations; (ii) credit scoring (estimating the
creditworthiness of a loan applicant based on profiling) and
(iii) credit self-evaluation (based on standardized formats
developed by the financial institutions themselves). Building
on the success of Banco del Estado with micro-credit, other
commercial banks could be encouraged to develop
specialized lines of credit for small and medium enterprises.
Strengthening Competition 30. Enhanced competition leads to lower prices and higheraverage productivity. Ease of entry is not, in itself, sufficient to
ensure competition because the number of firms is not the
only determinant of price competition, as discussed in
Galetovic (2005). For example, in the case of fixed-line
telephony, increasing the number of competitors barely
affects tariffs. Reducing and simplifying regulations is one
way to foster stronger competition; another way is to
redesign the market. Chile has been very successful in
achieving effective price competition in the long-distance
telecom sector but not in fixed-line telecoms, nor in the bus
system (where small firms predominate) or pension funds.5
Redesigning these markets will help reduce business costs,
increase productivity and welfare. According to some
estimates, removing barriers to competition in the pension
system could halve current costs (Valdes, 2005).
31. The evidence is inconclusive when it comes to perceptionsof competition being restricted by bank concentration. Cross-
country comparisons suggest that Chile is not different
from the international norm with regards to bank
concentration. But high profits reinforce perceptions of low
competition. IMF (2005) tentatively associates low
competition with high effective entry costs (in the form of
high capitalization ratios), limited competition from other
non-bank financial intermediaries and regulatory
restrictions on the investment of private pension funds
(which are the largest institutional depositors). Further
analysis is needed on this issue.
32. Measures to reduce costs or foster tough price competition aremarket specific. To identify the determinants of market
structure from cross-industry regressions is difficult if not
impossible. The first order of business is to make a systematic
survey of sector rules and regulations that impair competition.
That could be done by the competition policy authorities. For
example, there is potential scope for redesign and further
liberalization of markets for public transport, telecoms,
electricity retailing and private social security funds.
33. The two main legal institutions in charge of competition inChile are the “Fiscalía Nacional Económica” and the CompetitionTribunal. The Fiscalía is charged with monitoring market
behavior and prosecuting anticompetitive acts; its aim is to
defend the public interest. The Tribunal hears and decides
cases involving alleged anticompetitive practices.The Tribunal
cannot initiate an investigation but it can suggest changes to
laws if it deems them harmful to competition. Unfortunately,
many times the rulings of these institutions have protected the
market from firms that were cutting prices aggressively, as
opposed to those involved in anticompetitive practices
(Galetovic, 2005). Government also affects competition
through discretionary administrative decisions by sector
20
Table 2. Creditor Rights, Rule of Law, Days Needed to Enforce a Contract, Days to Collect a Bounced Check, Effective Creditor Rights, and Volatility of Credit
Chile 2.0 1.251 305 200 0.263 0.064Australia 3.0 1.882 157 320 0.490 0.031Canada 1.1 1.864 346 421 0.186 0.038Italy 2.0 0.901 1390 645 0.228 0.061New Zealand 4.0 1.989 50 60 0.675 0.032Spain 2.0 1.239 169 147 0.262 0.058South Korea 3.0 0.763 75 75 0.321 0.049United K. 4.0 1.883 288 101 0.654 0.038USA 1.0 1.750 250 54 0.157 0.030Brazil 1.0 -0.207 566 180 0.058 0.136Mexico 0.0 -0.275 421 283 0.000 0.213Uruguay 2.1 0.537 620 360 0.205 0.098Hungary 1.0 0.771 365 365 0.107 0.160Slovenia 3.0 -0.401 275 60 0.144 0.111
DEFINITIONS: Creditor Rights: secured creditors protection in bankruptcy procedures. The higher the score in a 1-4 scale the greater is the enforcement of creditor rights. Rule of Law: Includes severalindicators that measure the extent to which agents have confidence in and abide by the rules of society. Days to Enforce a Contract: number of days to resolve a payment dispute through courts. TotalDuration of the Procedure: the number of days needed to collect on a bounced check. Effective Creditor Rights is the product of Creditor Rights and Rule of Law (both normalized between 0 and 1).
Source: Djankov et al (2004), Kaufmann et al (2003 and 2004), and Galindo and Micco (2001).
Creditor RightsCountry Rule of Law Days to enforcea Contract
Days to collect abounced check
EffectiveCreditor Rights
Volatility ofCredit Growth
Std.Dev
5. See Chart 2.1 in Volume 2.
ministries, as well as through regulations applied by
Government agencies.
34. Strengthening institutions will help to increase effectivecompetition. Two potential safeguards that might be used to
prevent firms misusing the system and forestalling
competition are (a) higher standards of economic analysis by
competition institutions (for claims are seldom supported by
rigorous analysis, let alone by empirical evidence); and (b)
allowing the Tribunal to dismiss cases that are have no
economic justification and are not well justified by the plaintiff.
d . I n n o v a t i o n
35. Cross-country analysis indicates that the roughly 50
percent of growth that is unexplained by physical factor
accumulation - total factor productivity - is often associated
with advances in the use and generation of knowledge and
innovation. This has led Chile, as many OECD governments, to
focus on how to enhance their performance in this area and to
consider reforms of the national innovation system. This
section examines three issues. First, how can Chile know if it
has an “innovation problem” that needs to be addressed?
Second, given that the evidence suggests that Chile does
indeed have an innovation problem, what is meant by
innovation and in what way does the country exhibits
weaknesses? Third, what do recent experience and the
literature suggest by way of measures to foster innovation?
Does Chile Have an Innovation Problem? 36. Compared to the OECD, Chile lags substantially with
respect to several common indicators of innovation
performance. These include expenditure on Research and
Development (R&D), participation of the private sector in
R&D, the issuance of relatively few patents and the excessive
relative importance of basic vs. applied research. Chile also
performs relatively poorly with respect to international
benchmarks for educational (see section E) and human
resources devoted to R&D.
37. However, neither these, nor low TFP necessarily suggestdeficiencies given the country's level of development. There is
strong international evidence that TFP is closely linked to the
capital-labor ratio. It is possible that Chile's relatively low
level of TFP simply reflects more general barriers to physical
capital accumulation. However, it appears that this is not the
case. Chile has a relatively low TFP even taking account of its
capital stock and that suggests a problem that goes beyond
general constraints affecting physical investment. It is an
open question whether the shortfall in TFP is due to a lack of
innovation or to other types of inefficiencies. Nevertheless,
given the need for key industries to remain internationally
competitive, and given the important role that innovation
has played in comparator countries such as New Zealand and
Spain, it would appear that that innovation merits a
prominent place on the reform agenda of the next decade.
Two issues are particularly important in that context.
38. First, “innovation policy” goes hand in hand with the
development of entrepreneurship focusing,as in New Zealand,
on business mentorship, competition policy, and incentives to
“get off the island”and export-- thereby creating a demand for
innovation. Because of its small domestic market and the
distance from larger metropolitan markets, Chile is more like
New Zealand than Spain or Italy which, within the European
Community, were readily exposed to competition and other
ways of doing business in a broad market.
39. Second, innovation policy goes beyond Science and
Technology (S&T) policy. Even if low TFP were entirely a
function of insufficient technological progress rather than
other factors, those other factors may still need to be
addressed (including underdeveloped venture capital markets
and labor market rigidities) because they may act as barriers to
the adoption of new technologies and S&T investments.Hence
promoting innovation requires a broad vision barriers to the
adoption of new technologies and S&T investments and a
broader set of diagnostics than those related to S&T alone.
40. In sum, if there is no demand for innovation on the part of
the private sector, either because of investment-related issues
or specific barriers to innovation, efforts to improve S&T on
the supply side will not lead to productivity growth. The firm
remains central to the discussion.
What is Meant By Innovation and what are the Aspects ofInnovation in which the Country Exhibits Weaknesses?41. There are different recipes - combinations of innovationinputs - that have served to achieve high-income levels.Adjusting four commonly cited ingredients for technological
transfer-R&D, Foreign Direct Investment (FDI), licensing, and
higher education - for level of development suggests that
Chile and the high tech miracles Finland, Israel and Korea
have followed very different recipes. Chile has relied little on
R&D or licensing and heavily on FDI. In that respect, it
resembles Spain and Italy both of which converged rapidly to
high income levels over the last 30 years (Figure 5).
42. There exists a large potential for non-R&D driven TFP growthin Chile. In both Italy and Spain, the literature suggests that
gains occurred largely through moving the work force from
21
low productivity to higher productivity sectors and
increasing the productivity of those sectors through the
adoption of existing technologies and through
improvements in organization and management. The system
of Technological Centers in Spain in particular, has been
central to enhancing the capacity of SMEs through clustering,
networking and cooperatives. It is important to foster those
less glamorous aspects of innovation.
43. Investment in S&T/R&D is nevertheless important over themedium term and appears essential over the longer term. R&D,
and a strong scientific capacity is critical not only to generate
new knowledge, but also to enhance the “absorptive
capacity” of enterprises-the ability to use and benefit from
existing information. The ability to absorb local publicly
funded, or globally available research and FDI is an acquired
skill. Technology transfer is closely tied to the private sector's
capacity to understand, adapt and commercialize knowledge
and technology. That, in turn, depends on having a pool of
technologically literate employees in the private sector. It is
they who will engender the demand for innovation, identify
and act on opportunities for innovation and, as they gain
experience, manage a firm's innovation strategy. At present, a
large majority of researchers in Chile work in universities or
public research institutes and only about 6 percent are
employed in the private sector. Thus, it is important for Chile
to provide stronger incentives for the cross-sector mobility of
researchers, expand on recent efforts to employ young
researchers in industry, and stimulate a culture of
entrepreneurship in graduate education.
44. The recent slow growth in Italy and Spain points to theimportance over the longer term of investment in S&T which areincorporated into R&D. Though the process of technology
adoption and invention cannot be neatly divided into distinct
phases there is, particularly in Spain, an acute sense of having
exhausted the “easy” phase of technological progress. Figure 6
suggests that, in Chile and Argentina, businesses rely more
upon physical capital accumulation as a means of acquiring
innovative technologies than upon R&D and training. The
contrasting behavior of Finnish enterprises may reflect their
specialization in electronics. The overall picture for Europe
suggests a greater emphasis upon building human capital and
in-house research capabilities over the long run.
45. Strengthening the S&T capability of Chile requires goingbeyond increasing the number of research units and the stock ofwell trained human capital, to the diffusion of knowledge.22
72
21.5
10.5
0-.05
-1-1.5
-2-2.5
77 82
Finland
87 92 98
FDI R&D Royalties Education
72
2
1.5
1
0.5
0
-0.577 82
New Zealand
87 92 98
72
21.5
10.5
0-.05
-1-1.5
-2-2.5
77 82
Chile
87 92 98 72
2
1.5
1
0.5
0
-.05
-1
-1.577 82
Spain
87 92 98
Hence the National Innovation System is to be viewed as a
network that facilitates the flow of knowledge. Evidence from
the OECD suggests that, at the micro level, knowledge
generation is subject to decreasing returns to scale while at
the aggregate level, there are constant returns to scale. That,
in turn, suggests significant synergies. In Chile, however,
knowledge creation is subject to diminishing returns at the
national level which suggests that synergies may be less
prevalent.6 The explanation may relate to such factors as the
level of education, the perceived quality of research
institutes, the degree of collaboration between research
institutes and the private sector and issues relating to
intellectual property rights. These are all central aspects of
policy design in the context of a National Innovation System.
What Does Recent Experience and the Literature Suggestfor Principles and Broad Policy Measures to FosterInnovation? 46. Although there still remains room for less exotic sources ofproductivity growth, a well functioning National InnovationSystem (NIS) is indispensable for full participation in theinternational S&T community. Reform of the NIS and
particularly the S&T System - realigning incentives, building
or dismantling institutions, identifying successful
interventions - may take several decades. Basic challenges of
the NIS include: (i) providing a policy framework for
innovation with a longer term focus on S&T; (ii) ensuring an
environment consistent with all types of capital
accumulation by redressing bottlenecks in the markets for
credit and labor and by encouraging competition; (iii)
attending both to innovation itself and to the entrepreneurial
and scientific capacity required to effectively innovate; (iv)
placing the private sector at the center of innovation policy in
order to establish a clear link with productivity; (v) evaluating
policies and procedures constantly and thoroughly.
47. In practice, the actual structure of the NIS in Chile may be lessimportant than a well-designed system of incentives and linkagesbetween institutions. Despite recent progress, the policies and
programs for R&D in Chile are still uncoordinated and there are
significant overlaps in content and objectives.That reduces the
impact of expenditures, generates duplication and leads to an
excessive dispersion of programs including to some areas with
relatively low social rates of return. Until recently, the National
Commission of Science and Technology (CONICYT), the entity
mandated by law to define an S&T policy, was unable to
coordinate policy among the various actors, or effectively
monitor Government programs. The recent proposal of a
“Consejo Nacional de Innovación” establishing a central Council
for policy definition, implementation, coordination and
evaluation is likely to lead to better overall coordination and
less redundancy. It would also have the power to allocate the
proceeds of a recently enacted Mining tax.
48. Much of the evolving strategy will focus on redressingproblems arising from the partly public-good nature ofinnovation. Good policy design balances the cost and
effectiveness of taxes, subsidies, and other methods of
“internalizing the externality,” including intellectual property
rights. Policies can be broadly divided into:
• Government sponsored innovation-related tasks:Governments often finance or perform basic research that
may have high social value but low private returns. It is
important to carry out an evaluation of the areas that are
likely to yield high social returns.Two principle institutions
23
Source: Authors elaboration based on enterprise innovation surveys in Europe and Chile.
Licences, patents, and introduction of innovation
Traininng for innovation
Machinery and equipment
Internal research and development
2.5
2
1.5
1
0.5
0
Spain Italy Finland Avg. Europe Chile Argentina
6. See Bosch, Lederman and Maloney (2005).
developed for that purpose are Universities and Public
Research Institutes (PRIs).
• Private sector led tasks: Private initiatives are preferred
in areas where the gap between the social rate of return
and the private rate of return is smaller. There are three
common instruments for transferring resources to the
private sector: Tax Credits, Intellectual property generated
rents and Public-private hybrids (matching grants).
49. A clear policy framework can support private-sectorinnovation with public funds. Notwithstanding successful
examples from the OECD and Asian experiences, there is, as
yet, little best practice that enjoys the broad support of
theoretical and empirical literature. Furthermore, it is not
known how effectively the apparently successful experiences
of other countries can be transplanted to Chile. Hence, the
principles proposed below can be viewed as a process of trial
and error.
Government Sponsored Innovation Related TasksUniversities and the formation of human capital50. From the point of view of developing a strong capability inscience and technology, it is of paramount importance tostrengthen the universities. The local production of research-
trained scientists and engineers remains low in Chile with just
144 PhDs in 2003. However, the number is likely to increase in
the near future due to efforts by CONICYT and the Ministry of
Education through its MECESUP program to strengthen
doctoral programs. Between 1999 and 2003 enrollment in PhD
programs almost doubled. Despite their prominent role,
universities are severely constrained by a lack of faculty with
advanced education and by a lack of research equipment and
laboratories. Efforts to stimulate quality research are slowed by
conservative practices and structures of compensation that
emphasize seniority rather than performance.
51. At the most general level, the universities' mandate canbenefit from greater clarity. Even though universities are the
principal agents of research (45 percent of R&D) and the main
employers of researchers (60 percent of all researchers) they
do not turn science into business. More than 55 percent of
R&D resources are dedicated to basic research (compared with
18 percent in the US) and that indicates there is room for
realigning the focus of research towards the needs of a middle-
income country. Chile would benefit from a practical vision of
university research as the handmaiden of industry.
52. Establishing a role for stakeholders in the governance
structure and allowing a larger role for competitive fundingwould increase the accountability of universities to externalaudience. Chile is in the process of introducing institutional
performance agreements for publicly funded universities
that would tie funding from “Aporte Fiscal Directo” to more
effective collaboration between universities and industry in
matters of research. A partial shift of funding to a competitive
basis, as both Finland and New Zealand have done, would
encourage researchers to heed the needs of the private
sector. Other issues of high-level education are addressed in
greater detail in Section E.
53. The mix of competitive and base funding in both universitiesand PRIs would benefit from enhanced monitoring. Competitive
financing, particularly relating it to links with the private sector
has the advantage of getting the incentives right in terms of
maintaining quality, encouraging linkages, and aligning
research with established national goals. However, the burden
of constantly applying for grants, the fragmentation of the
research agenda, and the inability to take a long run view of
more risky research can discourage research in projects with a
potentially very high social rate of return. This suggests that
some degree of base financing will always be necessary.
54. Chile has made important advances in shifting from asystem dominated by small individual grants to multiyeargrants to finance equipment and advanced training for researchgroups. Chile now has about 80 research groups - including
centers of excellence, science nuclei, advanced research
teams and consortia - funded by CONICyT, MIDEPLAN, CORFO
and FIA. Building a critical mass by further concentrating
funding in a few strategic areas would stimulate excellence
and strengthening Chile's ability to tap into networks of
international knowledge.
55. Some universities have begun to develop polices for
intellectual property rights, and there is growing interest in
incubators. The most successful is the Engineering
Department of the Catholic University which has supported
the creation of five new spin-off companies. However, in
general, there is a lack of tradition among universities for
stimulating entrepreneurship. Incentives to establish such
amenities as accessible laboratory space or expanded access
to young researchers are still quite limited. Again, the Catholic
University Engineering Department has the most developed
program in terms of promoting exchanges.
Public Research Institutes56. The role of Public Research Institutes in the NIS varies
24
Ver Bosch, Lederman y Maloney (2005).
greatly from the relatively diminutive in Sweden to the
protean ITRI in Taiwan. PRIs are most relevant where they work
with the private sector, but are independent of it. Their task is
to set standards, and to a lesser extent, disseminate
technologies and coordinate the various actors in the field. In
practice, some functions, especially dissemination, are
discharged by universities (such as agricultural technologies
by Universidad de Chile). However, the dissemination of
applied technologies may require quite different incentive
structures from basic research so that separate institutions
may be called for. With that in mind, an evaluation of PRIs
would be useful in Chile. As yet there has been no
comprehensive evaluation of how well they may bridge the
gap between the private and academic sector, what is the
social return on their research or how important is the public
good component within their research. The role of technical
institutes such as those in Spain as intermediaries between
PRIs and businesses may also be worth exploring.
57. As with the universities, a central design issue for PRIs is the
structure of funding. In New Zealand, for example, a reduction
in base financing led the Crown Research Institutes to behave
more like private consulting firms and to deemphasize their
role in providing public goods.Fundación Chile has successfully
identified new products within the framework of Chile's
natural resource endowment, has conducted the necessary
research to develop them, and has introduced them to the
market. It has played a central role in discovery that has helped
introduce new products, most notably the salmon. A
fundamental question is whether there are other long term
investment projects in their portfolio that could be undertaken
if higher levels of base financing were forthcoming.
Private Sector Led Innovation Related Tasks58.There are areas of innovation where governments lack the
ability to choose projects and where the gap between the
social rate of return and the private rate of return is small. In
those areas the preferred strategy is to let the private sector
take the lead.Two main policy instruments have been used to
assist firms invest in R&D: tax credits and matching grants.Tax
credits (which are not used by Chile at present) can lower the
cost of innovation without specifying the sector, leaving the
individual firm to assess profitability. The econometric
evidence suggests that tax credits effectively increase total
R&D. However, they often subsidize investments that would
have taken place anyway without tax credits and there may
be a mismatch between private and social returns.
Furthermore, tax auditors frequently lack the expertise to
distinguish between true R&D and other expenditures that
firms may claim. In Hybrid/Matching Grant Schemes, the
private sector proposes projects and helps finance them, but
a Government agency monitors performance in return for
sharing the project cost or facilitating co-financing. These
schemes encourage networking between sectors with
relevant expertise and they permit better targeting to
projects with high social returns.
59. In Chile today, technological institutes, together with
firms, universities, researchers, etc, compete for a diverse array
of demand driven subsidies offered mainly by CORFO and
CONICYT. They provide co-financing of between 30 percent
and 100 percent, depending on a number of criteria including
the benefit to the private sector, the nature of the research,
the involvement of universities and technological institutes,
the size of the project and so forth. Econometric evaluations
suggest that they increase investment in technology and also
increase productivity. The amount of co-financing could be
fine-tuned to ensure active private sector commitment.
Other Barriers to Innovation: An Open Research Agenda60. There are other barriers that constrain TFP apart from the
NIS as it relates to S&T issues. According to a recent survey of
businesses, resistance to change from senior management,
and the cost of labor redundancy both act as barriers to the
adoption of new technologies. However, the evidence for this
is weak at the present juncture and it merits more research.
The same survey finds that firms do not undertake more
innovation because of technological risks and long gestation
periods. Credit markets may not provide the type of finance
needed by firms to deal with the lumpiness, risk and long
gestation periods of innovative projects. It is not known
whether the low utilization of venture capital constitutes a
constraint or whether it reflects a low demand for innovation.
Numerous VC firms have been started and their failure is
potentially suggestive of barriers to innovation. Some VC
managers argue that the lack of a project pipeline reflects a
shortage of upstream financing by angel or other start-up
investors. Other managers suggest that the pipeline exists
but that VC firms previously neglected the management
dimension of financing that plays a central role in the US. A
more careful examination of innovation financing is
warranted within the broader context of business start ups.
e . E d u c a t i o n
61. One of the more important barriers to innovation in Chile is aninsufficiency of human capital. Education is critical to achieving
high and sustained growth. It also may be the most useful tool
for increasing equality of opportunity and thereby improving
equity in Chile.
25
62. The education reforms begun in 1990 led to significantincreases in education investments and to a substantialexpansion in the quantity and quality of education. The
additional education investment has meant significant gains
in terms of education coverage. However, challenges remain
with respect to access at certain levels and, especially, with
respect to improving quality and equity in the education
system. The State has an important role to play in easing
constraints in the education market and in guaranteeing that
all children have access to education of an adequate quality.
Investment in Education 63. Investment in education is high in Chile. Total expenditure
in education as a percentage of GDP almost doubled
between 1990 and 2002, increasing from 4 to 7.6 percent. As
a result of increased education investments, the level of
education expenditures relative to GDP is similar to
developed countries and even greater than the average of
OECD countries. The proportion of private expenditure in
education is greater than most other countries (Figure 7).
Access to Schooling and Inequality64. Despite significant increases in the educational attainmentof the population at all income levels, 53 percent of today's adultpopulation in Chile has not completed secondary school. Low
schooling levels are particularly prevalent among the poor
(Figure 8). A remaining challenge is to provide educational
opportunities to under-schooled adults, especially to those
from low income backgrounds. In 2002, the Government
launched “Chile Califica”, a program designed to provide
opportunities for adults to complete their basic education
and acquire technical skills for the labor market.
65. Substantial gains in access to secondary school wereachieved in the 1990s, with secondary school enrollment ratesreaching 87 percent in 2002. At the same time, there was a
significant reduction in secondary school dropout rates, from
10.3 percent in 1991 to 8.5 percent in 2002. The increase in
coverage is associated with a notable expansion of private
subsidized schools, a product of the early 1980s reforms,
particularly in secondary education. The coverage of
preschool and higher education has expanded greatly since
1990, although preschool enrollment rates remain low by
international standards.
66. While the secondary school enrollment gap between high-and low-income students narrowed between 1990 and 2003,the gap between high- and low-income students in preschooland higher education enrollment rates remains substantial.Inequalities by ethnic background also persist.
Higher Education Expansion, Quality and Equity67. Since 1990, traditional universities have doubled theirenrollment, while there has been a substantial expansion ofenrollment in private higher education institutions. In the
coming years, the demand for higher education is expected
to increase as a result of demographic trends as well a higher
rate of secondary school completion (Eyzaguirre, Marcel,
Rodríguez and Tokman 2005).
68. Improvements in efficiency, especially in universities, havelagged. While the graduation rate in non-university tertiary
institutions is comparable to that of OECD countries, it is
substantially lower in universities with only 29 percent of
university entrants graduating in the required time
compared with an OECD average of 76 percent (Brunner et al,
2005). This low graduation rate implies that resources are not
being used efficiently, and that Chile is developing advanced
human capital at a slower pace than its potential.
69. Equity of access to higher education remains a challenge, butthe current administration has taken important steps to provide
26
Source: OECD (2004a). Note: There are differences between data reported by OECD and MINEDUC, OECD considers academic year from September to May and MINEDUC considers calendar year from January to December. Private Public
876543210
Ireland Mexico OCDE(average)
Argentina Korea EE.UU Chile
students with financing options. Funding for the “créditosolidario” program has increased but it is confined to students
who attend traditional universities and they constitute only a
half of all students in higher education. In 2005, a parallel
financing system was introduced for students attending
private and non-traditional universities, as well as technical
and professional institutes. Moreover, the Government is
modifying the principles for allocating resources under the
old student aid system. Beginning in 2006, students will
receive support based on their score in the university
entrance exam, their socioeconomic profile and a newly
introduced reference tuition fee which reflects the efficiency
of the institution they are attending with respect to teaching
and research. Universities are divided into four sub-groups
according to the results of institutional accreditation. Each
year the reference tuition fee for each group will be equal to
the actual tuition fee of the university with the highest
performance rating and the lowest tuition fee. Hence, the
new system promises to strengthen the link between tuition
and quality while providing an incentive for institutions to
improve their performance.
70. The recent expansion of higher education has also createdchallenges for prospective students and employers becauseinformation on the quality of new programs and newinstitutions is lacking. In an effort to reduce the information
gaps, a national accreditation system for higher education
systems is being developed (Brunner 2004). Finally, since
1998, the Government has sought to improve the quality and
relevance of tertiary education by introducing competitive
funding. Financing from this source has been extended to
over 300 university-based projects designed to improve
teaching and university management.
The Quality of Primary and Secondary Education 71. National and international test results suggest that
educational quality in Chile is low and shows little improvement.Average scores in the national SIMCE assessments during the
last few years - and in particular since 1998 when the tests
began to be standardized - show a worrying lack of progress.
Furthermore, a substantial gap exists between the average test
scores of Chilean students and those of students from other
countries in international assessments of student learning,
including the Third International Mathematics and Science
Study (TIMSS) and the Programme for International Student
Assessment (PISA). Even the best Chilean students -- those in
the highest percentile of achievers (who, in most cases, attend
private fee-paying schools) do not perform well when
compared with their counterparts in other countries or even
with the national average of other countries (Table 3).
72. Schools that show no progress co-exist alongside schools
that show continuous progress. Differences are not
necessarily associated with the socio-economic level of the
students. They appear related to educational processes that
are difficult to identify and replicate. It will be difficult to
redress shortcomings in the absence of a strong technical
capacity in schools as well as in municipalities and private
providers (sostenedores).
73. The large increase in education coverage in recent years hasdepressed average test scores, especially in secondary education,because children who otherwise would have been outside theschool system and who tend to have poor educational scores arenow enrolled in school and are included in the assessments.Comparisons of SIMCE scores across school types (private fee-
paying, private subsidized, municipal) do not accurately
measure quality differences, because they do not take account
of differences in the resources available to schools. Studies
that adjust for available resources reveal that differences
scores are substantially less when school and family resources
are taken into account. Nevertheless, private fee-paying
27
Sample 20 percent with lower income and sample 5 precent total country. Base: individual aged 25 years or more.Source: 1992 and 2002 Census.
16141210
86420
1 2 3 4 5 6 7 8 9 10
4,14,9 5,4
6,2 6,47,4 7,1
8,27,7
8,9 8,3 9,5 9,010,2 9,8 11,1
11,0
12,312,9
14,0
1992
(richest)(poorest) socioeconomic decile
2002
schools continue to show better results than private
subsidized schools, which, in turn, show better results than
municipal schools (Mizala and Romaguera 2001, Sapelli and
Vial 2002, Gallego 2002).
74. Although differences in average SIMCE scores betweenprivate and municipal schools are significantly reduced afteradjusting for student socioeconomic background, the gap hasimportant implications for public policy. To guarantee equal
educational opportunity, all students should have access to a
high quality education independent of their circumstances.
75. Given the resource gaps that exist today, the pooreststudents deserve to be provided with additional resources. The
standard subsidy per student discriminates against students
from low socioeconomic backgrounds because they require
above-average attention and educational resources.
However, increased resources alone will not solve the
problems faced by the Chilean education system. Education
reforms in Chile would need to take account of existing
market failures and could foster competition between
schools that may lead to improved education quality. A
particularly difficult challenge will be to enable students from
the lowest income quintiles to access higher education.
Recent efforts to diversify student finance options for higher
education are a step in the right direction. To improve the
overall cost effectiveness of education, the continuous
evaluation of policies and programs is important.
The Education Market in Chile 76. Decentralization, initiated in the early 1980s, transferred
public school administration to municipal governments. It
also opened the way for private sector providers to participate
in publicly financed education by establishing a voucher-type
student-based subsidy. The goal was to generate an
“education market” that would foster competition and thus
encourage efficiency and improve the quality of education.
77. However, differences between subsidized private andmunicipal schools have impeded the creation of an“educational market”. Public and private schools compete
under different conditions, thus limiting the gains in
efficiency and quality that would have been expected from
the voucher-type student subsidy. As a result, the Chilean
education “quasi-market” has been unable to raise average
student achievement in the system as a whole, and it does
not even ensure a high quality education for the elite
(Eyzaguirre, Marcel, Rodríguez and Tokman 2005).
78. The most important differences between subsidized
private and municipal schools are threefold. First, as far as
student admissions are concerned, subsidized private schools
can select their students while municipal schools are required
to admit all applicants. Second, with respect to teacher
contracting, subsidized private schools can directly hire and
dismiss teachers, but municipal schools cannot. Third, private
schools have alternative sources of finance.
79. For a competitive education system to encourage quality,parents need to be fully informed about school quality. Well-
informed parents can exercise control, demand quality from
the schools and, if the school does not respond, they may
transfer their children to a different school. In this sense,
information on the quality of education institutions may be
considered a public good. To be effective, this information
should be comparable among institutions, easily understood,
28
Table 3. Chile's educational performance is low when compared to the OECD (Percentile Distribution of PISA 2000 Mathematics Scores, by Country)
Latin America 357 177 286 432 530Chile 384 222 321 449 532Mexico 387 254 329 445 527Argentina 388 180 307 474 574EE.UU. 493 327 427 562 652OECD (average) 500 326 435 571 655Korea 547 400 493 606 676Japan 557 402 504 617 688
Source: MINEDUC
AverageCountry Percentiles
timely, and accurate. The greater the proportion of well-
informed consumers, the more efficient will be the education
market (González 2004). Indeed, the success of market-based
education reforms depends on the extent to which parents
can make informed decisions over the range of options that
are available.
80. A recent study by Elacqua and Fábrega (2004) finds that
the reforms in Chile have not generated a critical mass of
informed education consumers that can effectively demand
improvement. Parents, they find, have few sources of
information and have weak information networks. They have
few options in choosing between schools and their choice is
based on very little specific information. Information on
school quality available to parents is limited to the average
SIMCE score for the school.That information is not very useful
because school averages mask important differences of
education quality. More importantly, as Elacqua and Fábrega
(2004) document, parents are concerned with factors other
than test scores. The information that parents are able to
access depends more on their socioeconomic background
than on the education system itself.
81. There is limited information on the quality of highereducation institutions in Chile which creates real constraints toinformed decision-making by students and their families(Brunner 2004). A promising initiative to improve the
information available to potential entrants to tertiary
education programs consists of a labor market investigation
of tertiary education graduates. The country has set up a
tracking system to follow the performance of tertiary-level
graduates in the labor market in order to monitor the quality
and relevance of programs. This investigation uses tax
information to track the earnings of tertiary-level graduates
in all major occupations. Reliable information on labor market
outcomes has enhanced the transparency of Chilean tertiary
education and provides prospective students with a basis for
making informed decisions.
The Role of the State in Ensuring Quality and Equality ofEducational Opportunity 82. The accountability of public institutions could be improved.The presence of multiple actors - the Education Ministry,
municipalities and private owners, head teachers, teachers,
pupils and parents - often leads to confusion about who has
the responsibility for the quality of education. Publicly
financed private and municipal schools in Chile have little
accountability to Government and to the public in general
regarding how they use resources from the student-based
subsidy. Raising standards for schools to access public
subsidies would be an important step towards increasing
accountability in the education system. As Eyzaguirre, Marcel,
Rodríguez and Tokman (2005) observe, an education system
as decentralized as Chile's requires higher teaching standards
to guarantee that children will have a command of basic
skills. In that regard, the current administration is designing
“maps” of student skills for each grade to guide schools and
teachers in their classroom work as well as to help in
evaluating school performance.
83. The respective roles of the Central Government andMunicipal Governments could be reformulated and schoolscould be granted a degree of autonomy depending on results. In
the current education system, the Ministry is in charge of
technical-pedagogic issues, while the municipalities are
responsible for administration. In practice, the municipalities'
assume little responsibility for student learning while the
Ministry underestimates problems related to school
management. Under an alternative model, a centralized
system could design and evaluate policies and a
decentralized apparatus could be charged with effective
school management and supervision. However, given the
diversity of the education system, schools and municipalities
would benefit from differentiated levels of autonomy and
supervision. Greater responsibility and autonomy could be
granted to high performing schools, including authority for
the use of financial and human resources. Thereby,
decentralization would be enhanced and there would be a
stronger link between quality and finance, which today is
weakened by the role of the municipality. Greater
decentralization and autonomy would be predicated on
explicit performance standards for schools and their
teachers. Under-performing schools would receive greater
attention and supervision from the Ministry and municipal
governments, which would increase their pedagogic and
administrative assistance. Intervention in schools with
consistently poor performance could be considered,
including the transfer of students to other schools.
84. Teachers play a central role in ensuring school quality.Attracting and retaining highly qualified and motivated
teachers is a necessary prerequisite for education quality. This
will require a multi-year agreement with teachers to secure
their participation and commitment to educational reform.
Chile has made important reforms with respect to teacher
incentives.Between 1990 and 2002 teachers' salaries increased
156 percent in real terms. During this period, the Government
launched a recruitment drive and established a scholarship
program for outstanding students to study pedagogy. At the
same time, the Government allocated substantial additional
resources to schools, thereby improving overall working
conditions for teachers. During this period, there was a 39
29
percent increase in the number of students and the average
score of applicants to education programs increased by 16
percent.
85. The structure of teacher salaries in Chile continues to be
relatively flat, especially when compared to that of non-
teachers (Mizala and Romaguera, forthcoming). Teacher pay
increases with seniority with little regard for the scope of the
teachers' activities or the teachers' effectiveness in the
classroom. High-performing teachers are underpaid. In spite
of the awards that have been introduced for teaching
performance, a large part of the teacher salary supplement
reflects years on the job rather than performance. Beginning
in 2006, a school-based performance award for teachers,
Sistema Nacional de Evaluación del Desempeño de losEstablecimientos Educacionales (SNED), will account for a
bigger proportion of a teacher's salary. The size of the award
will have increased by 91 percent between 2004 and 2006,
and as a result, teachers in a SNED-winning school will earn
about double what they earn today.
86. Ensuring equity of educational opportunity remains one ofthe biggest challenges for Chile's educational system. Students
from low and medium low socioeconomic backgrounds have
substantially lower test scores than do students who come
from more privileged socioeconomic backgrounds (Table 4).
Even more important than differences in test scores is the
school segregation by socioeconomic background that has
taken place as a result of the student-based voucher system
(Cox 2005). Indeed, Hsieh and Urquiola (2003) find that the
voucher program has led to increased polarization, with
middle-class students leaving municipal schools for the
private sector.
87. The current student-based subsidy is provided equally to
all students, independent of the student's socioeconomic
background. A standard voucher leads to significant
differences in educational results and encourages
discrimination against students from lower socioeconomic
backgrounds by schools that are able to select their students.
Several countries have introduced differentiated vouchers to
compensate for differences among students. Recently
proposed legislation would introduce a student subsidy
differentiated by socioeconomic background. The law would
include a preferential subsidy to qualified students in pre-
kinder through fourth grade of basic education. Under the
scheme, schools would comply with certain quality criteria to
receive students with preferential subsidies and sign an Equal
Opportunity Agreement (“Convenio de Igualdad deOportunidades”) with the Ministry agreeing not to reject
students.
88. While most children from the highest income quintile attendpreschool, the proportion of children from low-income familiesattending preschool is very low. The gap in preschool
enrollment rates by income background is troubling because
preschool attendance has been shown to have important
effects later on school outcomes. Raising preschool
enrollment rates overall and especially among the poor
would likely improve educational outcomes and reduce
inequality both in education and in the labor market.
89. Improving equity of access to higher education is alsoimportant, and Chilean secondary and tertiary institutions facethe challenge to work together to bridge the gaps in access totertiary education. To a great extent, inequities in tertiary
education stem from problems of quality in secondary
education and low completion rates among students from
poor and indigenous backgrounds. Recent efforts to expand
access to financing for students attending tertiary education
institutions deserve to be strengthened. Moving toward a
results-based framework for allocating resources to tertiary
education institutions will foster improvements in quality.
With only 5 percent of direct public funding (AFD) for
30
Table 4. SIMCE 8th Grade Test Results, 2004
Socio economic group Language Mathematics
Low 229 232Medium low 234 235Medium 253 253Medium High 280 282High 301 311National Average 251 253
Source: SIMCE, MINEDUC
traditional universities allocated on a performance basis,
there is room for strengthening accountability by tying
incentives to the achievement of key sector priorities.
Supporting the Evaluation of Education Policies andPrograms90. Evaluation of education policies and programs is necessaryboth to make adjustments if necessary during implementationas well as to design effective reforms for improving quality andequity. The Chilean education system has made substantive
progress in designing indicators for the evaluation of policies
and programs. However, more can be done. Panel data of
students, teachers and schools would enable the evaluation
of education policies and programs to be improved. The
evaluation of policies and programs has positive externalities
that can benefit a broad range of public interests. Hence,
Government support for the evaluation of education policies
and programs is important.
91. Evaluation can be built into program design. In Chile, the
introduction of a preferential subsidy for students from low-
income households as well as the introduction of a new
student loan scheme for students attending non-traditional
universities and non-university institutions could be
accompanied by a comprehensive impact evaluation.
f . E n h a n c i n g s o c i a l p r o t e c t i o n
92. While education can go a long way toward creating equitableopportunities, it is rarely sufficient for overcoming the risks towelfare affecting the most vulnerable. Recovery from economic
shocks may undermine human capital or hinder investment.
Although there are wide differences between countries, social
protection policies are generally intended to safeguard
human capital. Social protection systems (comprising policy
interventions, public institutions, and the regulation of private
institutions) aim at helping families manage shocks to their
income that may otherwise threaten their human capital.
Given the well-established links between human capital and
economic wellbeing, social protection is a key instrument in
the fight to alleviate poverty and increase equity.
93. Protecting human capital is also critical to promoting andsustaining economic growth. Where households do not have a
sufficiently wide array of tools with which to insure against
risks, they may need to spend scarce resources recovering from
shocks that could otherwise be put to productive use. Where
there exist few options for mitigating the losses from shocks,
households may avoid potentially profitable but risky
investments-for example, adopting a new, more productive
technology,-for fear of failure. Since there are many risks that
cannot be covered by private insurance, there is a clear role for
Government in sheltering households from those risks.
94. Social insurance-the principal instrument for socialprotection in most countries-should protect households frompoverty provoked by an income shock. Social assistance should
gradually lift the currently-poor above the poverty line.Thus, a
country's poverty indicators are ultimately the most relevant
and objective criteria against which to evaluate its social
protection policies.
95. Judged by these criteria Chile has done extraordinarily well,even if the progress in eliminating poverty is due to a broader setof policies than social protection. For most of the late 1980s and
1990s, poverty in Chile declined.This achievement was mainly
associated with economic growth-the fruit of market-friendly
policies and prudent economic management-as well as with
increases in targeted social spending. However, although
there are fewer poor households the level of indigence
remained stubbornly high since the mid 1990s, and has only
recently begun to fall. Chile continues to have one of the
highest levels of economic inequality in the developing world.
Finally, many households remain vulnerable to poverty from
adverse income shocks such as job loss, costly treatments for
injury or sickness,and the losses to income associated with old
age. A recent Bank report-“Household Risk Management andSocial Protection in Chile” (World Bank, 2004a)-concluded that
Chile largely succeeds in providing households with the
instruments needed to mitigate shocks to their income and to
protect their human capital.
96. The instruments Chile has put in place to help householdsmitigate losses from income shocks are generally well designed.Nevertheless, too many Chilean households, even among the
non-poor, still do not have access to social protection. Lack of
coverage continues to be a pressing concern. The principal
shocks to income are often correlated. Households who earn
incomes close to the poverty line are made particularly
vulnerable to an array of shocks if members have lost
employment. If they have lost a job in the informal sector or are
among the self employed whose businesses fail, their
vulnerability is compounded by explicit and implicit barriers to
even basic forms of social protection. Since a significant
number of uncovered workers are not counted as poor, the
relatively well targeted social safety net that Chile has in place-
including its flagship policy initiative for the poorest, ChileSolidario, launched in May 2002-will not extend to them.
97. As an indication of the magnitude of the problem, 12
percent of working men from urban households and 20
percent from rural households were employed without a
formal contract of employment, while 21 percent and 33
31
percent respectively, were self employed. The percentages are
even higher further down the income distribution. Thus theover-arching challenge for policy makers in social protection is toextend coverage to these vulnerable groups without creatingmoral hazard or dependence, and without impairing opportunityand enterprise.
98. The following sections explore the main shocks to
household welfare - unemployment, the costs of health care,
and the losses that arise with ageing. It provides a summary
assessment of the institutions Chile has in place to cover the
losses. The final section contains policy recommendations.
The Main Risks to Household Income Security, Outcomes,and Remaining Challenges in Social ProtectionChanges in Risks and Coverage 99.The point of departure for this analysis is an assessment of
the risks households face, and how they vary between urban
and rural households and between income groups. Risks to
earnings-capacity and income are classified by age bracket
(see Tables 5.1 and 5.2 in Chapter 5, of Volume 2). For example,
the risks to future earning capacity that affect ages 0 to 5 are
malnutrition and failure to attend pre-school. Later in life, lags
in educational attainment, unemployment or employment
without a contract (i.e. “informal employment”) can pose a
risk to income and human capital. Risk indicators are
specified. The coverage of Government programs to help
households manage risks is assessed.
100. In every age group there was noticeable improvement from2000 to 2003. Risks are generally lower, particularly in the area
of education. For example, failure to send children to primary
school fell by over 18 percent among indigent households in
urban areas, and by over 35 percent among the poor in rural
areas. However, progress towards mitigating risks to earnings
directly related to the labor market-from low labor force
participation; unemployment; non-professional self
employment-has been mixed. Although more job seekers
from poor and indigent households found jobs with a
contract, unemployment among the rural indigent increased
by 33 percent and among the rural poor by 16 percent. The
poorest households continue to be the most vulnerable in
the labor market.
101. Chile's households are relatively well covered by socialprotection programs, and beneficiaries of these programs tend tobe from the lower income brackets; however, gaps in coverageare still apparent especially among the poor and in rural areas.From 2000 to 2003, Chile succeeded in reducing many of the
gaps in coverage, particularly among lower income groups.For
example, coverage of health and pensions rose among
indigent and poor households in rural and urban areas alike.
While definitive evidence is still pending, much of the progress
may be attributable to the Government's concerted efforts to
eliminate indigence since 2002 through Chile Solidario. Yet
there remain many gaps in coverage. For instance,
unemployment benefits (both non-contributory transfers and
payments from insurance) cover less than 6 percent of jobless
in poor and indigent households.
102. Preliminary evidence concerning the impact of ChileSolidario may help to explain some of the outcomes observed
among households in the lowest income groups. After June
2004, the first families who entered Chile Solidario through
FOSIS' Puente program in 2002 began to graduate from the
first two-year phase of the initiative. During the first stage of
the Puente program, the degree to which households met the
53 minimum conditions targeted by the program varied
greatly from region to region. Participating household found it
especially difficult to (i) keep household income above the
indigence line; (ii) secure adequate housing; and (iii) keep at
least one working-age adult in regular employment.
Changes in the Risk of Job-loss and Extended Periods ofUnemployment103. The functioning of the labor market is particularly
important for social protection since that is where most
households gain access to Government programs designed to
help manage risks. From the household's perspective, labor is
among the most important of family assets, particularly for the
poor, and earnings from employment are typically the largest
source of income.Thus, the income lost from extended periods
of unemployment is serious in most cases and may even be
catastrophic. From the perspective of social protection policy,
the critical question is whether the risk of extended
unemployment is high, and whether social protection policies-
including minimum wage and job security provisions-are
compounding the risk or hindering the effectiveness of other
instruments of social protection.
104. There is increasing concern that Chile's labor may be losingefficiency (Figure 9). These concerns have been compounded
by the relatively high rate of unemployment since the last
major recession in 1999 when unemployment rose to levels
not observed since the mid- 1980s. Since 1998 minimum
wages have increased by about 20 percent in real terms. Social
protection policies-including the minimum wage and social
insurance contributions-raise the cost of labor. Comparative
research shows that the minimum wage in Chile is relatively
high and an effective constraint upon the labor market.
However, despite the rise in labor costs, contracted
employment increased slightly from 2000 to 2003.
32
105. Although the long economic slowdown that began in 1998took a serious toll, the incidence and duration of unemploymentin Chile can be attributed in part to policy factors. The effect
upon the labor market of changes in job security remains
ambiguous. However, after adjusting for the impact of the
business cycle, increases in the minimum wage significantly
raise not only the risk of unemployment but also the risk of
losses from protracted periods of joblessness. The duration of
unemployment fell in 2001 but the average duration has held
steady since then and slightly increased in 2004 despite a
lower rate of unemployment.
106. A preliminary assessment of “Chile Solidario” shows thateven families who have graduated from the first phase of theprogram find it hard to stabilize income and employment.Despite three years of economic growth and a fall in the
overall rate of unemployment, men from the poorest
households in urban areas did not experience a reduction in
unemployment. Among men from the poorest households in
rural areas unemployment increased by 7.3 percent.
107. Chile's new unemployment insurance system will helpcushion losses of income, but the new system does nothing toincrease coverage. By shifting to pay-roll contributions as the
main source of financing, the system draws a sharper
distinction between the protection enjoyed by workers with
a legal contract, and those without one, including the self
employed. Nor is unemployment insurance, even if based on
individual accounts, likely to increase incentives for greater
“formalization”. The new accounts are not replacing a PAYGO
system, as old-age savings accounts did in 1981, and their
introduction has added to non-wage labor costs. However, it
is too soon to draw any definitive conclusions about the new
system. Now that the new unemployment insurance system
has completed its third year of operation, it would benefit
from an early and rigorous evaluation.
108. A recent evaluation of Chile's public employment programsfound that they covered only 9.7 percent of the unemployed and30.3 percent of unemployed heads of household in 2003. The
evaluation shows that direct programs seem to do a better
job of targeting the poor and indigent. Data are not available
that would allow an assessment of the extent to which the
Government's preferred employment-subsidy program
favors poor or indigent groups.
109. The new programs are not likely to reach the mostvulnerable. First, employers are likely to use the subsidies to
hire the most employable workers-that is, those who need
the subsidy the least-or to formalize workers already
employed informally. Second, by paying the minimum wage,
and offering pensions and social security coverage, the
Government may have created relatively attractive jobs with
above-market wages as well as social insurance coverage. To
the extent that publicly created or subsidized employment is
relatively attractive (especially to workers who would not
otherwise join the labor force), it will be politically very
difficult to eliminate those positions and move workers into
private sector jobs or eliminate job-creating subsidies in
periods of economic growth. If the Government cannot easily
dismantle costly public employment programs, it may
hesitate to introduce them again in future recessions.
110. Workers in the informal sector, and the self employed
whose income suffers in a down-turn, have easier access to
public employment programs than to contributory schemes
33
Source: OECD (2004b and 2004c)
5550454035302520
Kore
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Cze
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Un
ited
Stat
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Mex
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Pola
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Can
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Spai
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OEC
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New
Zea
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Ch
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Un
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Kin
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4341
7. The cost of labor indicator shows the legal minimum wage and the corresponding social security/pay-roll contributions paid by employers where there is one,as a percentage of the average wage. The data are taken from 2002, the last year for which comparable statistics have been published.
such as unemployment insurance. The PEPs, particularly FOSIS
PRLE and the SENSE employment subsidy, seem to be
succeeding in placing some of the unemployed in jobs and in
upgrading their skills. There remain concerns, however, not
with the programs' job-placement function, but with their
income-protection function. Participation is conditional on the
presentation of a finiquito (proof of unemployment) and that
excludes informal sector workers and leaves them without an
alternative instrument to mitigate losses from unemployment.
111. Furthermore, if the minimum wage continues to rise asquickly as it has in recent years, there could be fiscalconsequences. Offering above-market wages imposes three
separate economic costs. It attracts more workers to public
employment programs, pays each of them more than they
would otherwise earn, and it may crowd out private
employment. As Chile's Government has discovered, if public
employment programs offer (or subsidize) above-market
wages, the fiscal costs of these programs can increase unless
access is rationed. But this places the Government in the
uncomfortable position of operating with quantitative rather
than price incentives. Since 2001 the number of hours and
work days under the direct employment programs has been
significantly reduced, and the number of beneficiaries of the
indirect programs was strictly limited to contain costs. In
effect, with regard to public employment programs, the
Government has substituted un-rationed, self-targeting forms
of income protection, with employment assistance that is
relatively expensive in terms of above-market wage costs and
which is strictly rationed and thus of limited coverage. Should
it again be faced with a deep recession in the wake of an
external shock as it was in 1998 and 1999, the Government
may have to re-consider this choice.
112. A binding minimum wage may be limiting employmentprospects for the very poorest groups that “Chile Solidario” aimsto integrate into society. In addition to targeting public
employment programs even more effectively to the very
poorest, Chile can learn much from the pro-active approach of
the United States and the United Kingdom to training and job-
search assistance. At the same time, it may be necessary for
Chile to reconfigure the minimum wage to ensure that it does
not discourage employment at the lower end of the earnings
scale.Further empirical research may be required on that issue.
The Risks to Income and Impoverishing Impact of Health Costs113. In the event of sickness or injury, medical expenses may
crowd-out other basic household expenditures and may even
constrain human capital development.The cost of medical care
can plunge households into poverty, and make it difficult for
the already-poor to escape from poverty. Hence, it is not only
important to maintain and improve the health of the
population, but also to ensure that households are protected
financially. Chile has recently taken significant strides to ensure
greater financial protection in the event of sickness or injury.
114. Out-of-pocket medical expenses are a good indicator of
financial vulnerability. In Latin America, 85 percent of private
health expenditures on average are paid out-of-pocket by
households. In Europe and the OECD the average is only 72
percent. By this measure, Chilean households may be
relatively less vulnerable, paying only 60 percent out-of-
pocket for health care.
115. Nationally, about 1 percent of households are newly-
poor as a result of health spending. 8 Households in the third
income quintile are the most vulnerable to impoverishment
provoked by health costs. About 5 percent of households in
that group are made poor by the cost of health care.
Households in the first and second quintile also have a
substantial degree of vulnerability.
116. To address this problem Chile, since 2002, has been
gradually introducing a new health insurance benefit
package (the Universal Access with Explicit Guarantees-or
AUGE Plan). AUGE establishes a minimum basic package of
health cover for all Chileans, along with guaranteed medical
treatment within specified time periods. Co-payments are
capped and the poorest households are fully subsidized. The
Chilean health finance reform is very recent and little
evidence exists yet concerning its impact on the poor. Initial
results look promising. The “explicit entitlements approach”is
already reducing financial vulnerability to health costs and
also raising the quality of health service delivered.
117. However, there are concerns for the financial
sustainability of AUGE.The subsidies implied by the ceiling on
co-payments imply new fiscal costs. The Government chose
to meet these costs through a modest increase in VAT and
through extending mandatory contributions to the self
employed who have previously been outside public health
schemes. There is interest in possibly shifting the financial
base for health coverage even further to VAT, which experts
agree would be more efficient and might even allow a
reduction in Chile's pay-roll taxes.
118. However, only a small number of countries have succeededin making such a transition, and the Government's earlier
34
8. See Bitran et al. (2002)
attempts to raise value added taxes were met by stiff opposition.Among the countries that have succeeded, Spain's experience
is of particular relevance. The shift away from pay-roll tax
contributions to broader based taxes could not be done
quickly. It would require a transition period during which some
risk-rating would have to be introduced to encourage workers
currently outside the system to take up coverage. At the same
time, poorer households would be protected with subsidies.
Covering the Risks to Income that Arise with Ageing119. The elderly frequently experience a loss of earnings and
increased health care costs. These stem from the loss of
earning ability, unanticipated longevity (that increases the
period of life when an individual has to consume but cannot
earn income from work) and, from these, an increased
vulnerability to poverty in old age. Chile's Government has an
array of instruments to help households manage these risks,
both directly and through the regulation of private pensions.
Structural reforms in 1981 shifted the system away from a
single-pillar “defined benefit”public pension to a “multi-pillar”
system in which the private financial sector plays a leading
role. The instruments are broadly efficient and effective.
Chile's multi-pillar pension system has two “first pillar”
instruments, the minimum pension guarantee (MPG) and the
targeted social assistance pension (PASIS) which pool the risk
of poverty. “Second pillar” savings (AFP accounts) and
annuities ensure and protect a minimum level of
consumption. In addition a voluntary “third pillar” of savings
(“ahorro provisional voluntario”, APV) receives
encouragement through tax incentives and regulated private
instruments.
120. In terms of protecting consumption and preventing
poverty, the benefits yielded by Chile's first and second pillars
can be compared favorably to mandatory plans in the OECD,
provided that workers fully participate.Whereas policy makers
in most OECD countries are concerned at the prospect of
financially unsustainable pension systems, Chile's pension
deficit is largely related to the transition-cost of the 1981
reform. The deficit currently averages 5.6 percent of GDP and
is gradually declining. However, in Chile (as in other Latin
American countries), participation in the system falls short of
the minimum necessary to secure financial targets.
121. In the past fifteen years, the proportion of the labor force thatcontributes to the pension system on any given month has rarelybeen higher than 60 percent.9 While this participation rate is
high by regional standards, surpassed only by Uruguay, it is
well below participation rates in the OECD. Contributions to
the system from most participants are irregular and are subject
to frequent interruptions. Upon reaching retirement, most
contributors do not have sufficient years of contributions
compared with other OECD pensions systems. The regulators
of the pension system in Chile estimate that well over 50
percent of participants will not even be eligible for the
Government minimum guaranteed pension. 10
122. Although research is far from conclusive, all else equal, lowrates of participation may be linked to the perceived high costsof the system which stem from insufficient competition betweenprivate fund managers. The three most important issues
confronting Chile's pension system are coverage, cost and
competition.11 There has been increasing criticism of private
fund managers who make high profits and fail to deliver
greater efficiency and cost-savings to households through
market competition. Low system coverage, lack of
competition and high costs are not only detrimental to the
effectiveness of system, they also threaten the system's
credibility. To the extent that the system loses credibility, the
important gains from structural reforms in the 1980s could
come under attack.
123. Recent changes to the retirement security system in Chilehave increased investment options for the private second pillar,increased price competition in the annuities market whichcaters to second-pillar affiliates, and have increased savings inthe voluntary third pillar. The Government is considering
further changes to the second pillar, with three specific
objectives in mind: first, to increase the rate of participation
by further enhancing incentives and lowering the
transactions cost of participation for the self employed;
second, to lower administrative costs by exploiting
economies of scale in account management; and third to
ensure cost savings are passed onto workers in the form of
lower commissions, by ensuring greater competition in the
industry through the strategic use of auctions.
124. The Government's ideas for changes to the second pillar
are very promising, and recent moves to strengthen the third
pillar are also extremely positive. However, as mentioned
above, up to half of participants have poor contribution
records and as many as 19 percent of men and 32 percent of
women are not even enrolled in the pension system.
Furthermore, the tax incentives for voluntary retirement
savings-which have been found to be regressive in several
countries-are likely to have only a modest impact on savings
35
9. Valdes and Beyer, 200410. Bernstein, Larrain and Pino (2004 and 2005)11. Valdes (2005), Gill, et al (2005)
because few Chileans pay income taxes. Gains from reforming
the second pillar and giving greater weight to the third pillar
could go hand in hand with consolidating and strengthening
the set of instruments intended to prevent poverty in old age-
both the non-contributory, rationed PASIS (currently set
roughly equal to the poverty line), and the contributory
minimum pension guarantee (which is roughly twice the
poverty line).
125. If all workers contributed to the earnings-related pension
system, the current structure of the minimum pension
guarantee would be relatively good. It encourages workers to
save privately and guarantees a minimum level of retirement
income at a minimum cost to tax payers. However, in countries
like Chile where many workers will not have a sufficiently long
history of contributions to the pension system, the current
structure of the MPG as a top up conditioned on participation
can not only exclude large segments of the population but
also lead to perverse transfers from all tax-payers to the
relatively well off workers in the formal sector.
126. Chile could move toward consolidating and simplifying itspoverty prevention pensions (the PASIS and the MPG) into asingle, perhaps pro-rated public risk-pooling device againstpoverty in old age. Ideally, that would involve setting a single
minimum benefit financed from general taxation, indexed to
prices, available at a retirement age that is periodically
adjusted to changes in life-expectancy, and targeted to the
elderly poor. However, the current limit on the number of
benefits paid needs to be abolished because it leaves
uncovered as many as 19 thousand women and 11 thousand
men who would otherwise qualify for the PASIS. Once a non-
contributory old age benefit is put in place, a contributory
minimum pension guarantee or matching contribution
scheme targeted at lower-income workers would cease to be a
“first-pillar” device and would instead encourage more low-
income workers to participate in the second-pillar.
Summary of Key Policy Options for Social Protection127. The over-arching challenge for policy makers in social
protection continues to be extending coverage among
vulnerable groups - particularly individuals earning wages
near the poverty line, who are engaged in unregulated,
informal employment or who are self employed - while
avoiding moral hazard or dependence and, at the same time,
fostering opportunity and enterprise.
128. With respect to unemployment, the coverage of income
protection - including the contributory unemployment
insurance system, and public employment programs - is still
very low. There is concern that unemployment benefits from
the contributory system may be of too short a duration, in
light of the increasing average length of unemployment. The
structure of the new public employment programs limits
their effectiveness as an instrument of income protection. In
particular, they present explicit barriers to workers in the
informal sector. There is particular concern the beneficiaries
of Chile Solidario and other low-skilled groups may find it
difficult to find employment in the labor force. Job security
regulations and the minimum wage may be limiting the
employment opportunities for low-skilled groups. More
could be done to improve the efficiency and performance of
local employment offices.
129. With respect to the cost of health care, the AUGE reforms
have put Chile at the fore-front of financial protection through
the shift to an “entitlements approach”. Changes in the delivery
of health that care will be necessitated by the shift to an
entitlements approach will have to be closely monitored. To
finance the system, the Government could consider a further
shift away from the pay-roll tax toward general revenues.
130. With respect to the elderly, the Government has taken
bold strides in developing the third pillar of voluntary
retirement savings. It has also widened options for workers to
invest their second pillar mandatory savings and introduced
changes that have brought down the price of annuitizing
these savings. However, with respect to protecting a basic
minimum level of consumption, the Government could
consider two further measures. The first is a reform of the
second-pillar investment regime to gradually shift from a
compliance based approach toward one based on risk
management. The second is a change in the structure of fund
management to exploit opportunities for further cost-savings
and to foster competition so that the savings are passed-on to
participants in lower fees. Whether or not broader investment
opportunities and lower commissions attract greater
participation from households - currently a low 60 percent of
the labor force - Chile faces a pressing challenge to consolidate
its first pillar of poverty prevention. A good first step would be
to lift the numerical limit on social assistance pensions.
131. In Chile, there is no lack of formal institutions to help
workers manage risks to income. However, they are only
available to a minority of workers with legal, regulated forms of
employment. To extend that protection to the majority, the
Government can: (i) lower the cost of labor regulations and
increase regulatory enforcement so as to foster formal
employment; (ii) finance social security schemes from general
taxation rather than from levies on employment, and (iii)
introduce "self targeting" instruments of social protection that
are not based on formal labor contracts. Chile has already
36
advanced more than many other Latin American countries in
pursuing the first of those options. It can go further by
removing explicit barriers and quotas to minimum forms of
income protection as it improves its targeting and
enforcement capacity. It can also further encourage
households to take up instruments that will afford them more
than minimum coverage.
132.Above all,however, the best guarantee of social protection
is good macroeconomic management and employment
creating growth. Even the best designed social protection
system is a poor substitute for the welfare that comes from a
secure job. Ensuring that the economy is managed so as to
generate adequate employment and that labor market
policies facilitate rather than impede employment creation is
the most important aspect of sound social protection policy.
g . P u b l i c f i n a n c e i s s u e s i n d e v e l o p m e n t
133. Public expenditures will be subject to upward pressure
over the medium and long term as a result of demographic
factors, the convergence of per capita income to the level of
advanced countries and social demands. A key challenge will
be to respond to the pressure for increased expenditures
without impairing the prospects for growth and development.
134. Even if public expenditures are well structured so that
they are both pro-growth and pro-equity, the net effect on
growth and equity will hinge on how expenditures are
financed. That, in turn, depends upon the efficiency and
equity of the tax system as well as on other financial
arrangements - particularly the fiscal rule - that constrain
debt financing of public expenditure.
135. This section examines three issues. First, it reviews the
performance of public expenditures and identifies likely
trends over the medium and long term based on the
experience of comparable countries and Chile's own
expenditure needs. Second, it identifies key efficiency and
equity issues in the tax system and suggests policy options to
lower evasion/avoidance, improve efficiency and equity.
Third, it analyses Chile's fiscal rule and examines possible
options to improve its design over the short term as well as
longer term alternatives.
Public Expenditure - Development Needs 136. Social expenditures have grown fast since Chile returned todemocracy in 1990. The share of education rose from 11.1
percent of central Government expenditures in 1990 to 17.8
percent in 2003. Over the same period the share of health
increased from 9.1 percent to 14 percent (Figure 10).
137. In spite of rising social expenditure, Chile was able tomaintain fiscal surpluses for most of the 1990s. This was possiblepartly due to revenue performance and partly due to a reductionin the relative share of expenditures for defense, debt service andsocial security. The share of expenditures for defense
decreased from around 10 percent in the early 1990s to 7
percent over 2000-03. Falling debt and lower sovereign risk
spreads brought down debt service from 9 percent to 2.2
percent of GDP over 1990-2003.
138. The ratio of social expenditures to total public expenditures isrelatively high in Chile -70 percent compared with an average of 45percent in all countries for which data was available. This places
Chile at the same level as Uruguay, Switzerland or New Zealand.
As a share of GDP (around 15 percent) it is above the predicted
value based on a cross country income comparison. Social
expenditures include expenditures on social security, which are
low in Chile because the system was privatized in the early
1990s and the Government only pays for those individuals who
choose not to participate in the new system. Hence, Chile is
even more of an upward outlier among international
37
Source: Ministerio de Hacienda, DIPRES
Public Debt Transactions
Defense
Health
Education
2.000.0001.800.0001.600.0001.400.0001.200.0001.000.000
800.000600.00
400.000200.000
90 91 92 93 94 95 96 97 98 99 00 01 02 03
comparators than the 70 percent ratio may suggest.
139. Health, education and cash subsidies provided by theGovernment are targeted towards the lowest income quintiles(Figure 11). There has been an improvement in targeting in
terms of the share of subsidies that go towards the lowest
three quintiles. These transfers effectively diminish income
inequality (World Bank, 1997).
140. However, progress has been uneven. There has been littleprogress with educational subsidies since 1990 and a significantpart of them still goes to the wealthiest two quintiles. In 2003,
81.2 percent of education subsidies were received by the
poorest 60 percent of the population, compared with almost
90 percent for cash transfers, and nearly 100 percent for health
subsidies. Hence, an improvement in targeting educational
subsidies, which currently do not take into account the income
of recipients, can help to reduce income inequality still further.
141. International comparisons with countries that started from asimilar income level and have undergone periods of fast growthsuggest that new expenditure pressures are likely to emerge from:(i) demographic factors, (ii) social development needs and (iii) ademand for new public goods as income increases.
142. Demographics. The proportion of the population over 65
years old is projected to increase from the current level of 7.8
percent to 11 percent by 2020. An aging population will
increase the public costs of health and pensions. First, the
elderly have a higher incidence of sickness and they require
more expensive medical attention. The majority of older
people belong to the public insurance system (FONASA) and,
hence, the burden of an aging population will fall on the
Government. Second, the pricing system of public and private
insurance provides incentives for individuals at high risk to
shift from the private to the public provision of health as they
become older. The latter charges a flat fee for service, while
private insurances price their services according to the risk
profile of the insured.Third,as the population continues to age,
a greater proportion of the elderly will find themselves with
incomes that fall short of the State-guaranteed minimum
pension and they will need to draw upon supplementary
public pensions. The fiscal cost of minimum pensions to cover
old age, disability and widowers is expected to quadruple over
the next 15 years to over US$300 million by 2020.
143. Some of the causes of public expenditure growth can be
contained through structural reforms. For example,
regulatory reforms on the pricing of private-public health
insurance can help to contain costs. Proposed revisions of the
pension system - as discussed in section F - could also help to
contain costs by adjusting the retirement age from time to
time in line with life-expectancy.
144. Social development needs. There is an awareness in Chile
that public expenditures are an important vehicle for
redistributing income. It is also recognized that it is the task of
the State to ensure equality of opportunity. Both those factors
will likely lead to an increased demand for public services. As
the system of primary and secondary education approaches
universal coverage, society will demand a higher quality of
instruction which, in turn, will necessitate expensive teacher
training and other complementary services. Also, the number
of students in tertiary education will increase thereby
requiring greater resources for the Universities and grants to
students from low-income households as discussed in Section
E.Greater participation of women in the labor force will require
an expansion of the current system of childcare. Pre-school
education can also help to level the playing field for students
of diverse socio-economic backgrounds. Finally, social
programs will need to be expanded in order to lift from
38
Source: Ministerio de Hacienda, 2004
140120100
80604020
01990 2000 2003 1990 2000 2003 1990 2000 2003
IQ
Monetary Subsidies Health Subsidies Educational Subsidies
IIQ IIIQ IV
poverty the still large numbers of poor. The likelihood that
social expenditures will continue to increase is supported by
the experience of EU and OECD countries. In those countries
public consumption and investment have declined as
percentage of GDP. Only social transfers have shown an
upward trend over the past 25 years.
145. Demand for new public goods. As incomes reach a level
comparable to that of more advanced economies, and the
basic needs of the population are satisfied, it is likely that
society will demand new public goods corresponding to a
higher standard of living and the development of a
knowledge-based economy (as argued in Section D).
Expenditures relating to citizen's rights, environmental
protection, urban development, transport, pollution, justice
and security all tend to have an income elasticity greater than
unity in high income countries. Chile too, is likely to
experience increasing expenditures in those areas.
Public Expenditure and Economic Growth146. The experience of other fast growing emerging economiesprovides a basis for assessing the likely future trend of aggregatepublic expenditures in Chile. In the recent past, five countries
experienced an increase in income from around US$10,000 to
around US$20,000 over a period of twenty years in PPP terms.
That is where Chile may expect to be 20 years from now. The
fastest growing economy was Hong Kong, whose per capita
income went from US$9,043 in 1979 to US$23,863 twenty
years later. Singapore followed a very similar path. Ireland
lagged in growth during the first couple of years, but
eventually reached the same level of income by the end of the
period. Portugal provides the relatively low growth scenario, as
it reached a GDP per capita of around US$17,000.
147. These countries experienced a remarkable expansion oftotal public expenditures during the two decades when theireconomies were growing fast. Cyprus, Ireland, and Portugal saw
their real expenditures more than double, while Singapore
saw its expenditures grow fourfold. These experiences
indicate that the Chilean Government may expect much
higher public expenditures in the long run and, accordingly,
that it would benefit from exploring financing options.
148. The relationship between growth and public expenditure iscomplex. To begin with, the composition and efficiency of
Government spending are potentially more important than
size in explaining growth, poverty and inequality.The literature
distinguishes between 'productive' and 'unproductive' public
spending and analyses the different effects of each on growth
(Aschauer, 1989). Government expenditures enter the
aggregate production function directly in endogenous growth
models that include human capital as a factor of production.
Since public investments in education and health improve the
quality of human capital, expenditures in those areas should
have a positive effect on economic growth.
149. Perceptions that there is a trade-off between growth andequity through the tax and transfer system imply that publicexpenditures are inefficient. That implication is not supported
by the evidence in OECD countries. Lindert (2005) for
example found that welfare programs such as basic social
assistance, public health and pensions in OECD countries
tend to have pro-growth effects. If social public goods are
perceived by households to have a net benefit, labor taxes
may be neutral in the sense that they don't distort the labor-
leisure choice of workers. In that case, public spending need
not be a drag on growth.
150. The literature shows that well executed public spending oninfrastructure complements the efforts of the private sector, andin some cases it might be essential for economic growth. A
seminal paper by Aschauer (1989) found that public
investment had a significant effect on economic output in
the United States. Kamps (2004), using new capital stock
estimates for 22 OECD economies found a significant and
positive elasticity of output with respect to public
investment, thereby demonstrating that Government
investment is productive. Easterly and Rebelo (1994) found
that investment in communication and transportation
structures can have a positive impact on growth. However,
the empirical link has not been unambiguously established,
and the possibility exists that inefficient and costly public
projects may have a negative impact on growth.
151. In short, economic and social development will require
higher public expenditure which, in turn, can become an
important engine of economic growth.The financing of those
expenditures - examined in the following subsections - will
also affect growth and equity outcomes.
Financing Development - Taxes 152. Whether or not taxes impair growth is less controversial thanwhether public expenditures do. Taxes may distort decisions by
reducing labor effort (taxes on income), by creating
disincentives to save (taxes on saving), or by inducing a
misallocation of resources (when different sectors or regions
are taxed at different effective rates). Tax policy can also affect
equity and economic efficiency through collection/
compliance costs, tax evasion or avoidance. On the other hand,
debt financing-to the extent that it is perceived as future
discounted taxes-may also discourage work, saving or
investment and it can crowd out private investment through
39
higher interest rates. This subsection evaluates options for
reducing tax avoidance and evasion (horizontal equity),
improving tax progressiveness (vertical equity) and, more
generally, improving the overall efficiency of the tax system.
The Tax System153. The Chilean tax structure is dominated by the VAT, whichgenerates 50 percent of the total tax revenue. The strong
consumption orientation of taxation implies a relatively
regressive structure. Two other main sources of tax revenue
are the income tax (personal and corporate) and excise taxes
(cigarettes, alcohol, gasoline), which represent 25 and 13
percent of federal tax revenues respectively.The shares of the
three main sources of tax revenue have been relatively
constant over the last ten years. Tax revenues increased 46
percent in real terms between 1995 and 2004 but Chile's tax
ratio is still below the average of comparable countries
(Figure 12).
154. Chile's income tax has four categories as follows:
• The first category (corporate) applies a 17 percent
uniform tax rate (about half the rate prevailing in most
Latin American and OECD countries) to business income
on an accrual basis and to capital gains when assets are
sold.
• The second category (payroll) is a progressive tax with
eight brackets and a top marginal tax rate of 40 percent.
It is applied to salaries, wages and any form of
remuneration paid for personal services.
• The third category (surtax) is a progressive tax applied to
the worldwide income of residents from all sources. It also
has eight brackets and a 40 percent top marginal tax rate.
• The fourth category (additional) is a 35 percent tax
levied on income remitted abroad by non-residents, be
they persons or corporations.
155.Dividends received from Chilean corporations are exempt,
because they have already paid the First Category tax when
distributed. Taxes paid on first and second category taxes can
be credited against the surtax. Similarly, first category tax may
be credited towards any additional tax. Social security
contributions are levied at 19.7 percent and are deducted from
the payroll tax. There are numerous other exemptions and
deductions from the personal income tax including income
from investments in mutual funds, investment funds, and
rental properties, withdrawals from voluntary savings in the
pension system as well asincome from interest and capital
gains. Deductions include voluntary contributions to pension
funds, mortgage payments and scholarships.
156. The VAT, a tax on sales on goods and services, was
increased from 16 percent to 18 percent in 1990 and from 18
percent to 19 percent in 2003 to offset tariff reductions in the
context of free trade agreements with the EU, the US and
Korea. Exemptions include transport, financial services,
education and health, professionals, real estate rentals.There is
a special regime for construction whereby companies may
credit 65 percent of the VAT on their sales against their VAT
liability.Chile has a stamp tax levied on credit operations. As far
as excise taxes are concerned, it is noteworthy that the tax on
gasoline is four times higher than the tax rate on (more
polluting) diesel.
Tax Avoidance and Evasion157. Tax evasion and tax avoidance are sources of inequity(because individuals with similar incomes end up payingdifferent taxes) as well as market inefficiency (because it isdifficult to have a competitive market when some sellers evadetaxes whereas others do not). There is usually a positive
relationship between tax evasion and the cost of compliance.
Evasion is lower when there is withholding at source. More
generally, incentives for tax avoidance or evasion depend
upon the type of tax and the taxpayer as well as institutional
and cultural factors. In the case of Chile the main sources and
consequences of tax avoidance/evasion are:
(a) Foreign direct investment (FDI). The 35 percent additional
tax levied on remittances to foreign shareholders is likely to
encourage tax avoidance and/or discourage FDI because
international capital is highly mobile. Although there is a
credit for first category income taxes paid, the effective tax
on distributed profits is still 35 percent. When evaluating
incentives for tax avoidance, it is important to consider the
tax regime of the home country. In order to avoid double
taxation, some countries offer a foreign tax credit for
income taxes paid to foreign governments. However, a US
corporation, for example, only gets full credit for its foreign
taxes when the average foreign tax rate is less than the
domestic tax rate. The difference in the tax rate between
the home country and the foreign country becomes a
factor in deciding the location of investment. A high
additional tax rate can discourage companies from
investing in Chile if their home country does not have a tax
agreement with Chile or if it has a lower corporate tax rate
than the 35 percent applicable in Chile.
(b) VAT. Evasion was reduced during the early 1990s from
30 percent to 18 percent. It then increased to 25 percent by
1998 and has since steadily declined to under 15 percent in
2004.There are several mechanisms for evading the VAT: (i)
not issuing receipts for sales; (ii) buying counterfeit receipts
40
for supplies to increase the credit against VAT payments;
and (iii) reporting personal expenditures as purchases for
the business. In addition, Chile has special VAT regimes for
some sectors. Exemptions for real estate and for insurance
are estimated to have cost US$87 million in lost revenue in
2002. Similarly, the special credit to the construction
industry cost US$191 million in foregone revenue in 2002.
(c) Personal income taxes. Income tax may be avoided by
shifting reported income into lower tax categories or by
inflating “tax-deductible consumption” such as mortgage
payments, charitable contributions, and voluntary pension
contributions. Tax avoidance is possible because income
taxes are levied on a narrow income base equivalent to
gross income less deductions, exemptions and credits.
Data suggests that taxpayers who receive income from
more than one source are better able to reduce their tax
liabilities compared with taxpayers earning income from
labor only. On average, individuals paying only second
category taxes pay an effective rate that is 0.5 percent
points higher than individuals with a similar level of
income who pay surtax.
(d) There are legal loopholes (exemptions, deductions, tax
credits) through which taxpayers can reduce their tax
burden. In general, high-income taxpayers benefit most
from these loopholes.To assess the impact of loopholes on
the progressiveness of the tax structure, all tax credits
(except for tax credits originating in first or second
category taxes), exemptions and deductions were
subtracted from tax declarations.After subtraction,the rate
for the second bracket increases from 1.65 percent to 1.84
percent while the average rate for the top bracket changes
from 28.46 percent to 29.79 percent (Figure 13).
(e) Difference between corporate and personal income tax
rates. The relatively large gap in taxation between
corporations and persons may play an important role in
explaining tax avoidance because individuals incorporate
in order to benefit from a lower tax bracket. However,
Gordon (1998) shows that the ability to incorporate and
enjoy a low corporate tax rate relative to personal tax rates
encourages risk-taking, i.e., entrepreneurship. Since
entrepreneurship is beneficial for economic growth, lower
tax avoidance needs to be balanced against the benefits of
greater incentives for entrepreneurship.
Policy Options to Lower Tax Evasion and to ImproveEfficiency and Equity158. There is scope for improving the tax structure to increase itsefficiency, improve equity, simplify its administration andincrease overall compliance. The following options are
proposed:
(a) Income Taxes. Some tax credits, deductions and
exemptions can be eliminated to help to improve
horizontal and vertical equity, lower tax avoidance and
reduce administration costs. Specifically, the Government
could consider the gradual elimination of tax exemptions
for capital gains, investments in national mutual funds,
income from interest, and income from house rent.
Similarly, the Government could usefully re-examine the
rationale for national tax incentives. The Government may
consider reducing the additional tax rate of 35 percent on
non-resident dividends which would help lower tax
avoidance and foster FDI. The Government may also
consider lowering marginal income tax rates in order to
reduce incentives for tax evasion/avoidance and thus
indirectly improve (horizontal) equity.However, the benefit
of that option needs to be balanced against the negative
impact of lower marginal tax rates on equity.
41
Source: C. Agostini (2004).
5045353025201510
50
Tax
reve
nu
e/G
DP
Tax Ratio versus GDPper capita (1995US$)
GDP per capita
0 10000 20000 30000 40000 50000 60000
(b) VAT. The special rates on luxury items and non-alcoholic
beverages could be reduced to the standard rate of 19
percent. Revenues from the higher rates are very small and
there are no efficiency reasons to have a differential rate on
those items. Elimination of the luxury rates would reduce
the administrative and compliance costs of the VAT. The
Government could consider eliminating exemptions on
life insurance, professional services, real estate rentals and,
in particular, the special regime for construction. There are
no externalities or any other efficiency reason justifying
these exemptions. If the Government wants to promote
those activities it could provide direct subsidies.
(c) Other Taxes. The gap between diesel and gasoline
taxes could be bridged with a special tax on diesel
consumption. The present tax policy on fuels perversely
distorts incentives with respect to externalities such as
pollution. Some 16 percent of cars in Chile have a diesel
engine and, if the diesel tax were equal to the gasoline
tax, it would increase revenue by about US$120 million.
The Government may consider gradually replacing
revenues from the stamp tax with revenues from other
less-distorting taxes.
Financing Development - Fiscal Rule 159. In 2000 Chile adopted an anti-cyclical fiscal rule.12 The rule,
binds the central Government to a structural fiscal surplus
equivalent to 1 percent of GDP. To calculate the structural
fiscal surplus, fiscal revenues are adjusted assuming that the
rate of economic growth is on “trend” 13 and that copper-
Chile's main export-is trading at its long-term equilibrium
price. 14 Thus, when output is below trend and/or the copper
price is below the long-term reference price, a surplus of less
than 1 percent of GDP or indeed a fiscal deficit may be called-
for and that can serve a stabilizing anti-cyclical function.
160. The fiscal rule was conceived as a measure to break the pro-cyclical behavior of fiscal policy. When the rule was first
introduced, the common expectation was of buoyant copper
prices and an expanding economy. The fiscal rule was
designed as a means of restraining pressures to spend the
expected high revenues. Eventually, as the economy slowed
down after 2000, the rule served to accommodate higher
deficits in an orderly and predictable fashion without
impairing the underlying strong structural fiscal stance. In
practice, the rule has held up quite well so far. In the 4 year
period 2001-2004, the average cyclically adjusted surplus has
been about 0.8 percent of GDP compared with a normative 1
percent target. Public acceptance of the rule - linked in part to
its relative simplicity and transparency - has also held up
remarkably well.
161. Most criticisms of the fiscal rule have to do with itsimplementation. In particular, there is concern that the counter-cyclical stabilization potential of the fiscal rule may not be fullyutilized. However, there appears as well to be a strong
consensus that any major change to the rule (including
abolishing it) after so short a period would be a major blow to
42
Tax
Rate
s
Exemptions and Deductions
Actual
Non Tax Credits
Bracket
35%
30%
25%
20%
15%
10%
5%
0%1 2 3 4 5 6 7 8
12. The new rule is a self-imposed measure by the present government on its fiscal policy from 2001 to 2005.13. The methodology used to project GDP for use in Chile's Structural Balance Rule does not result in an estimate of the potential output of an economy at fullcapacity. Rather it extrapolates the previous actual trend GDP, subject to additional information on domestic and external variables.14. To increase transparency, the Government has delegated the estimation and projection of trend GDP and the long-term copper price to two committees ofexternal experts. Estimates employ a standard production function approach. The estimation of GDP is then “filtered” to separate the trend and cyclical compo-nents. A Hodrick-Prescott filter is used; since the H-P technique gives too much weight to the end points of a series, these are eliminated before projections aremade.
the credibility of economic policy, which in all probability
would damage Chile's creditworthiness.
162. Thus, any amendment to the rule should focus on technicalimprovements at the margin. Possible improvements include: (i)
extending the role of automatic stabilizers to expenditures
such as unemployment insurance and social programs, (ii)
improving the consistency between GDP and copper price
forecasts; and (iii) avoiding short-term changes in fiscal policy
within any fiscal year. To that end, the Government could plan
to correct the effects of shocks over a period of time by, for
example, aiming to reach a 1 percent structural fiscal surplus
on average over a number of years. The effects of irreversible,
and presumably larger, shocks could be adjusted over a longer
period than temporary ones. Similarly, adjusting the structural
surplus according to potential output is a desirable and
feasible option to help reducing variability of fiscal policy
within any one year. More substantial modifications to the
fiscal rule should only be considered on the basis of experience
once the rule has acquired enough credibility.
163. One key concern has been that the normative target of 1percent for the structural surplus is arbitrary. In the context of
Chile's growth performance and the prevailing interest rate
structure,a one percent structural surplus implies that the ratio
of debt to GDP will fall even though, at about 35 percent
(consolidating the central bank), the ratio is already relatively
low. Even if the quasi-fiscal deficit of the central bank were
close to 1 percent of GDP, the rule would imply-as long as GDP
grows-a continuous fall in the ratio of consolidated debt to
GDP. A falling debt ratio may constrain the ability of the
Government to finance investments with a potentially high
rate of social return. It would also limit opportunities for inter-
generational consumption smoothing. Moreover the financial
markets would be progressively deprived of an important
investment instrument and a useful benchmark in the form of
the yield curve. Over the medium term, as creditworthiness is
further consolidated and the credibility of the fiscal rule is
more firmly established, the Government may consider a
revision of the 1 percent structural fiscal surplus target. The
pros and cons of such a change would need to be carefully
examined and explained to the public. It would need to be
introduced gradually so as to test its potential impact on
perceived creditworthiness and credibility in general.
164. Over the longer term, as creditworthiness becomes a lessimportant consideration, the Government could consideradopting a rule whereby the debt/GDP ratio eventually convergesto the ratio of the stock of public capital to GDP (Giavazzi andPerotti, 2005). This would avoid a scenario under which all
public debt is eliminated at the cost, for example, of foregoing
public investments or expenditures with a high rate of return.
A fiscal rule that implies a convergence between the stock of
debt and the stock of public capital over time will also ensure
that the budget, excluding net public investment, would
remain balanced throughout the business cycle.
165. Such a rule would require an appropriate accounting
framework and the development of institutions that can
separate conceptually and in practice current expenditures
from capital investments. It would allow anti-cyclical fiscal
policy to be employed during the business cycle without
reducing net investments, which could be financed through
new borrowing. Whether this is a good idea in practice is not yetdemonstrable. It would depend upon the effectiveness ofincentives to reclassify current spending so that the rule could beeffectively implemented.
h. Risks to convergence with advanced economies
166. The Chilean authorities expect real GDP to grow at more
than 5 percent annually during the period 2005-2008. This is
equivalent to an annual growth in per capita real GDP of
about 4 percent. At these levels of growth, Chile would reach
Spain's current level of GDP in per capita PPP terms by about
2023. That level of output growth is achievable, barring anysubstantial change in the world economic environment andassuming that macroeconomic policies continue to bemanaged prudently as expected.
167. Chile is an outward-looking country and the policy
environment is conducive to the introduction of further
measures that would reduce its vulnerability to shocks,achieve
high growth rates and reduce the continued vulnerability of
the still numerous poor. Yet, some risks do remain.
168. This section will identify possible impediments that may
obstruct the convergence to Spain's current PPP GDP per
capita. It will also assess strategies - and policy options - to
reduce vulnerability to external shocks.
Sources of Vulnerability169. In 2004-a year when Chile's main exports enjoyed
particularly high prices -exports accounted for about 41
percent of GDP and copper accounted for 45 percent of
exports.The high growth rates seen in 2004 were due, in part,
to very favorable external conditions. Copper prices were
extremely high and continued to grow yet further to
historically high levels in 2005.
170. Being a small open economy, Chile remains sensitive toregional and global developments, and shifts in demand from its
43
major trading partners. A slump in the international demand
for primary products such as copper or fluctuations in capital
flows would substantially reduce short-term growth
prospects. In the past 100 years, major periods of output
fluctuation were caused mostly by adverse external shocks. Of
the six major economic fluctuations in Chile, five were
precipitated by exogenous shocks: the crisis in the nitrate
industry in the 1910s, the mining income collapse precipitated
by the Great Depression in the 1930s, the oil and copper crisis
of 1975, the debt and banking crisis of 1982, and the slump in
capital flows and commodity prices in the aftermath of the
Asia/Russia/Brazil crisis.
171. Looking at changes in copper prices plotted against GDP
growth over 1960-2004, the association is clear (Figure 14).
This close correlation with the price of copper represents asignificant risk for Chile, since prices are currently at extremelyhigh levels. Although there might be structural reasons (such
as continued strong demand from China) to expect a high
equilibrium price, the risk of a reversal towards the mean
remains a strong possibility.
172. Assisted by a trade liberalization agenda - including FTAs
with the EU, the US and various Asian countries - Chile has
diversified its exports towards non-traditional goods and
services -which have doubled as a share of exports since
1970-and towards new markets. Vulnerability to externalshocks will be reduced even more by continuing to increase thedynamism of the private sector, further diversifying economicactivity and trade and integrating the financial system withinthe world economy. There is also room to reduce vulnerability
through fiscal policy (section G), financial sector deepening
and international diversification in capital markets.
Reducing vulnerability: International risk-diversification
through the financial system173. Chile has consistently pursued fiscal and financial policiesaimed at strengthening its creditworthiness, and increasing thedepth, stability and international integration of its financialsector. The adoption of a fiscal rule and a floating exchange
rate regime combined with full-fledged inflation-targeting
go a long way towards insulating Chile from terms of trade
shocks and/or sudden-stops of capital inflows. Similarly, the
development of a sound regulatory and supervisory
framework for financial markets has reduced the
vulnerability of the financial sector. 15
174. Chile's financial system is large and well diversified. The
mandatory pension funds created in the 1980s' reform have
grown at a fast rate pulling in their wake most of the
financial system including banks, life insurance companies,
the mortgage industry and corporate bonds. The 1998
liberalization of the capital account and, in particular,
allowing pension funds to diversify their assets abroad has
helped Chile to deepen international financial integration.
Chile's foreign assets and liabilities as a share of GDP is about
50 percent higher than the share of the average emerging
country. Also, since mid-1998, there has been an increased
association between returns from local and international
equity markets. The rapid expansion of the market for
exchange rate hedges, facilitated by the expanding adoption
of hedging by pension funds, should also contribute to the
overall stability and resilience of the currency market. 16
175. There is scope for designing specific instruments which
would help to reduce yet further Chile's exposure to terms of
trade volatility - particularly, fluctuations in the price of
copper which weighs heavily on the budget. In emerging-
market economies the domestic financial market typically
allows only a limited diversification of risks. In such a
44
Source: Central Bank of Chile, the Federal Reserve Bank of St. Louis and WDI.
GDP annual growth
Change in real cooper price - right
15
10
5
0
-5
-10
-15
60
40
20
0
-20
-40
-6060 63 66 69 72 75 78 81 84 87 90 93 96 99 02
15. See “Chile - Financial Sector Assessment”, World Bank/IMF, August, 2004.16. See previous footnote.
situation, diversification through international capital
mobility is the obvious alternative. Cross-border transfers of
the ownership of real and financial assets-e.g. via
privatizations-- is one way to achieve diversification but it can
be costly to implement and even more costly to reverse.
Implementing these approaches to diversification often
conflicts with political objectives and constraints.
176. Over-the-counter (OTC) derivative contracts provide anappealing alternative for risk transfer.17 In the case of equity
swaps, for example, the total return per dollar on the small
country's stock market may be exchanged annually for the
total return per dollar on a market-value weighted-average of
the world stock markets. An equity swap would enable a small
country to diversify internationally without contravening
possible restrictions on the investment of capital abroad.18 Risk
diversification through derivative instruments is more flexible
than diversification through the transfer of assets.19 The
possibility of using swaps to diversify risk has been around for
a long time. What is different today, and allows swaps to be
used in significant volume and at low cost in practice, is the
convenience of an existing legal infrastructure. The value of
international equity-linked derivative notional contracts rose
from US$2.8 trillion in mid-2003 to US$4.4 trillion at the end of
2004.20 Over the same period, commodity linked contracts
rose from US$ 1 trillion to US$ 1.4 trillion.
177. Diversification through derivative instruments is thus analternative which the Government could explore to further reduceits vulnerability to terms of trade volatility. The specific type of
instrument would need to be defined. For example, the
Government could consider a swap with a global pension
intermediary in which it offers to exchange annually part of its
per-dollar “copper dividend” in CODELCO for the per-dollar
return on a market value weighted average of world stock
markets. An equity basket which is negatively correlated with
copper prices may actually do even better in terms of risk
diversification. However, there is no guarantee that the
correlations would never go the wrong way, and an episode of
“wrong” correlations would be very difficult for the
Government to explain to the public.
178. Without pursuing the details of implementation, the
swap effectively transfers the risk of the “copper dividend” to
foreign investors and provides the Government with the risk-
return pattern of a well-diversified world portfolio. Since
there are no initial payments between parties, there are no
initial capital flows in or out of the country. Subsequent
payments, which may be either inflows or outflows, involve
only the difference between the copper dividend and the
return on world stock market index, and no “principal”.
179. Alternatively, the swap could involve exchanging thecopper dividend for a risk-free interest rate denominated in a“strong” currency or in units of constant purchasing power. This
hypothetical swap would work the same way as the one in
the previous example, except that the net cash flows
produced by the swap would result in the Government
receiving a risk-free rate of return. The counter-party must
have a very good credit rating, or the swap must be
guaranteed by a third party with a strong credit rating, or by
a two way mark-to-market collateral. In economic terms, this
swap would not be very different from what the Government
is currently doing with excess copper revenues when copper
prices are above the reference price set under the fiscal rule,
i.e., accumulating reserves or buying back debt.
180.While capital markets may be prepared to accommodate
such financial transactions, the political economy of the
country may not be as well-prepared. The average voter may
be ready to accept that the Government is protected against
falling copper prices but may regard with scepticism that the
Government gives away part of its copper dividend when
copper prices are rising. Moreover, citizens may not like the
idea of the country paying a premium to buy into the
contract. Over time, some of these issues could be addressed
however. In this respect it is encouraging that the public
seems prepared to accept a fiscal rule that forgoes the
potential short run benefit of high copper prices whenever
these are estimated to be above the long run price.
45
17. See Giavazzi-Perotti (2005) and Mario Draghi, F. Giavazzi and R. C. Merton,“Transparency,Risk Management and International Financial Fragility”, NBER WorkingPaper Series, June, 2003.18. Swaps are over-the counter (OTC) instruments, traded outside organized exchanges. Trading swaps requires no capital. There are no rules governing marketconduct such as risk management, obligatory centralized trading, defined clearing and settlement rules, and loss-sharing rules in case of default. OTC derivativemarkets lack a formal structure; have no physical central trading place, and no clearing or settlement system. There is also no central mechanism to limit individ-ual or aggregate risk taking and risk management is completely decentralized.19. Caballero and Panageas (2003) suggest that Chile could eliminate most, if not all, deep recessions by embedding into its external bonds a long put option, yield-ing US$ 6-8 billions when the price of copper falls by more than two standard deviations for one or more semesters. They estimate that such an insurance, if fair-ly priced, might cost a lump sum of US$ 500 million. Caballero (2003) argues, however, that currently “there is no natural market for holding such an instrument,and the corresponding derivatives markets would not suffice to cover the position of the writer of the option.” Even in the best emerging economies, he argues,aggregate risk management is being done with stone-age instruments and methods. He thus concludes suggesting that the IMF has a key role to play here inresolving this impasse and becoming a catalyst for such a development. He proposes that “the IMF creates a new Contingent-Markets Department which shouldhave three primary tasks: (i) To help identify each country's contractible contingent basis and develop the corresponding contingent bonds; (ii) To help create andregulate contingent market CDO-like funds; (ii) To help design a macroeconomic policy framework consistent with the insurance mechanism developed for thecountry, and monitor its fulfilment.”20. See “OTC derivatives market activity in the 2nd half of 2004”, BIS.
C o n c l u s i o n s
181. Chile is in a strong position to achieve high growth and
increase equity, and to move towards convergence with the
advanced OECD economies. Achieving the objective of
strong and equitable growth will require a combination of
factors: fostering growth through a dynamic and innovative
enterprise sector; and raising the capabilities of the
population, particularly the poorer members of society,
through increased education access and quality, and
enhanced social protection.The biggest challenge for future
growth in Chile will be to reduce the high levels of
inequality and vulnerability to poverty. The country cannot
attain its growth potential if a large share of the population
is unable to reach their full human capacity potential. Not
one advanced economy has levels of inequality
approaching those found in Chile, and the accompanying
inequality of opportunity cannot but penalize Chile's
growth prospects.
182. A dynamic enterprise sector. Growth has already
been accompanied by a large reduction in poverty. Future
high growth rates will be central to continued efforts to
eliminate poverty and reduce the vulnerability of the poorer
strata of society. A dynamic enterprise sector in an economy
that fosters competition and innovation will generate the
growth and employment needed for Chile to reach its goal of
social equity and convergence with the income level of
advanced countries. Productivity growth in the traditional
export sectors and further efforts to develop the
nontraditional export sectors will be needed for the country
to fully exploit the new opportunities opened up by free-
trade arrangements. Policy options to dynamize the
enterprise sector include: strengthening competition policy,
reducing the cost to firms of entry and exit (particularly
bankruptcy procedures), lowering the cost of reallocating
labor across firms (job security provisions and minimum
wage), and improving access to credit.
183. A stronger National Innovation System. In spite of
substantial progress, Chile still has an uncoordinated wide
array of policies and programs for R&D and technology
diffusion with significant overlap across programs and
between content and objectives. This reduces the potential
effectiveness of limited funding. Basic challenges for Chile's
National Innovation System include: (i) providing a policy
framework for innovation with a special longer-term focus on
S&T; (ii) fostering innovation as well as the entrepreneurial
and scientific capacity required to effectively innovate
through the creation, adoption and adaptation of new
knowledge; (iii) placing the private sector at the center of
innovation policy in order to ensure the link to productivity
growth and to limit Government failures; iv) evaluating
existing initiatives constantly and thoroughly; (v) increasing
the stock of well trained personnel and research units; and (vi)
improving the diffusion of knowledge across units.
184. Increased education access and quality. Increasing
education levels is a means of targeting both high growth
and income equity. The education reforms begun in 1990
brought important increases in education investment and
led to a substantial expansion in the quantity and quality of
education inputs. The additional investment has translated
into significant gains in terms of education coverage.
Important challenges remain though: improving the quality
of education and raising the equality of opportunity. The
State can play an important role in guaranteeing that all
children have access to an education of good quality. The
State faces as well the challenge to ensure equality of
educational opportunity, particularly by promoting
preschool education and higher enrollment among the poor.
Another substantial challenge is to tackle the high levels of
inequality in adult educational attainment. The majority of
today's adult population in Chile has not completed
secondary education, and low schooling levels are
particularly prevalent among the poor. This is a huge barrier
to innovation and to equity. But raising adult education levels
will not involve education policy alone; the high levels of
47
informality in the Chilean economy deserve to be confronted
as they act as a barrier to on-the-job training.
185. Enhanced social protection. Nearly 18.8 percent of the
population falls below the official poverty line. Vulnerability
to poverty remains high. Many households remain vulnerable
to poverty from adverse income shocks, such as job loss,
costly health events, and loss of earnings-ability in old age.
This not only threatens the equity goal, but also damages the
outlook for growth. Recovery from shocks can even impair
households' human capital or hinder further investment. The
over-arching challenge for policy makers in social protection
is to improve coverage among the potentially vulnerable
groups, primarily through the elimination of explicit barriers
to programs of social protection where they exist. This has to
be complemented by further improving incentives for
households to take up instruments that promise more than
minimum coverage. Ensuring that the economy is managed
so as to generate adequate employment and that labor
market policies facilitate rather than impede employment
creation remains the most important aspect of sound social
protection policy.
186. Financing development. It is unlikely that the
Government will suddenly depart from the supportive
macroeconomic policy environment that has been put in
place. However, the quest for higher growth and the
achievement of higher growth will put pressures on Chilean
Government finances. This report has assessed likely
pressures on Government expenditures that will arise from
further growth and development needs as well as the
financing options that are available to the Government. In
particular, there is scope for improved efficiency and equity
and reduced tax avoidance/evasion through: eliminating
numerous income tax credits, deductions and exemptions;
reducing the withholding tax on dividends of foreign
corporations; eliminating VAT exemptions such as those for
life insurances, professional services, real estate rentals, or the
special regime for construction. There are also opportunities
to refine-and over the longer term reform-the fiscal rule so as
to increase its anti-cyclical effectiveness while protecting
public investments with potentially high social returns.
Finally, risk diversification through international capital
markets provides a suitable option to further reduce Chile's
vulnerability to terms of trade volatility.
A g e n d a f o r F u t u r e R e s e a r c h
187. The DPR has covered selected important issues of
concern for the development agenda in Chile. The report was
not designed to be comprehensive. A number of key policy
challenges have not been covered and they could be
considered potential areas for future research. They include
labor market participation, pre-school education,
determinants of informality, decentralization and pension
reform. An overarching theme for future research is the
strategy for reducing inequality. Several sections of this
report (specially sections E and F and to a lesser extent
section G) have partially dealt with policies aimed at
improving equity. The issues and policies to be addressed in
future research are strategically important for - and indeed
should focus on - the equity issue.
188. Labor market participation/pre-school education.Differences in labor income are closely related to inequality.
Diverging labor income can be explained by differences in
education, but also by differences in labor market
participation. Increasing labor market participation among
the poorer groups in society is then central to increasing
equity. Bringing under-employed groups into the labor
market would also boost growth. In Chile, the participation
rate of women is less than half that of men. Employment
amongst young people is also low. Family size and childcare
options are other important factors in decisions to
participate in the labor force. An increase in preschool
facilities may be one means of assisting women. This would
have the added advantage of helping to equalize
opportunities in terms of educational outcomes because
there is growing evidence that socio-cultural factors
influence performance from an early age. Likewise,
increasing the availability of temporary and part-time jobs
for the young in education may be important for raising their
participation rates. Ensuring that institutional rigidities do
not discourage female or youth employment is also crucial
for labor market participation.
189. Informality. If entrepreneurs, salaried workers in large
firms and in the public sector, and self-employed
professionals are included in the formal sector, there has
been a moderate decline in informality over the period 1990-
2003. However, at 37 percent in 2003, informality in Chile is
still high. High informality has implications for equity as it
hampers the effectiveness of the social protection system
and, typically, those employed in the informal sector have
lower incomes. Also, as discussed, it may impact on growth
because the informally employed have fewer prospects for
improving their human capital. A dual labor market is an
obstacle to the reduction of inequality in general, and tends
to deepen inequity in difficult times.
190. Decentralization. Given Chile's objectives with respect
48
to decentralization and efficiency, it would be useful to carry
out a review of institutions at the regional level. There may
also be grounds for a realignment of support schemes for
regional development to better reflect existing regional
income disparities, productive potentials and the differential
regional impact of structural reforms - in particular, of Chile's
FTAs. 21 For example, the southern regions that specialized in
import-competing crops such as wheat may not easily
diversify towards nontraditional exports, particularly since
they are not well-endowed with human capital and
infrastructure. One way of tackling this problem may be
through integrated regional or territorial policies. More
generally, decentralization faces severe institutional
constraints - the capacity of regional and local administrations
to manage efficiently the resources transferred by the central
Government. This suggests a need for strengthening
institutional capabilities at the local and regional level prior to
further decentralization. There is also scope to deepen
decentralization, fine-tune the respective responsibilities of
different levels of government, and improve the effective
utilization of revenues and transfers by giving more discretion
to municipalities along with greater accountability.
191. Pensions. The shortcomings of the private fund
management industry are widely recognized, especially in
relation to the objective of providing greater efficiency and
cost-savings for households through market competition.
The fundamental concern-which is related to the high
operating costs of the private system-is low system coverage
and, hence, high contingent fiscal liabilities. As mentioned,
Chile could consider moving toward consolidating and
simplifying its public pension schemes into a single public
risk-pooling device against poverty in old age. Once a non-
contributory old age benefit is in place to cover poverty, a
contributory guaranteed minimum pension or matching
contribution scheme targeted at lower-income groups would
cease to be a first-pillar device and could instead increase
incentives to participate in the second-pillar. These and other
options deserve to be carefully examined.
S u m m a r y o f P o l i c y O p t i o n s
192. A matrix is presented of the key policy options presented inthe DPR for the achievement of high and equitable growth inChile.
49
21. Chile's progressive integration into the world economy is likely to impact the regional landscape in different ways. Agricultural products of the south faceincreasing competition from imports. Of special concern is the situation of low income wheat producers.There has already been a 28 percent reduction in the landunder wheat cultivation since 1989 and many farmers have abandoned wheat cultivation altogether. On the other hand, some areas surrounding the northernports stand to benefit from a very dynamic trade with Asia and China in particular.
M a t r i x : R e m a i n i n g c h a l l e n g e sa n d p o l i c y o p t i o n s
51
Promoting Sustainable Productivity Growth
Remaining challenges
Reducing business costs wheretechnically feasible
Reducing barriers to enhancedcompetition
Reducing the cost of reallocatingresources between firms
Improving institutions ruling oncompetition policies
Key policy options
Enforcement of creditor rights and bankruptcy law. Enact the Second Capital Market Reform Bill (i) to create aUnified Registry for all movable assets pledged as collateral, as well as information pertinent to lenders; and (ii)to introduce modern rules dealing with the treatment of off-set and netting of financial contracts in insolvencyproceedings; and (iii) to introduce provisions which clarify the treatment and effect of subordination debtagreements in bankruptcy.
Utility companies and private social security. Based on specific sector analysis, consider measures to redesign and-where needed- further liberalize markets for public transport, telecoms, electricity retailing and private pension funds.Banking sector. Further analyze sector to conclude on the sources of perceived low competition associated withhigh bank profitability.
Labor issues. (i) Consider a redesign of the provisions for job security with the aim of reducing the severancepayment component and increasing the unemployment component thus keeping neutral the change; (ii)evaluate the feasibility of tying the level of minimum wages to observable variables such us unemployment.Evaluate alternative wage indexation options with the aim of making at least one wage component flexible.A first order of business is transparency of data in the private and public sector.Credit issues. Consider FSSA recommendations to increase efficiency and make the financial sector resilient toshocks. Consider recommendations of World Bank study on small and medium enterprises. Evaluate thefeasibility of establishing market-driven schemes including mutual guarantee associations to ensure sustainedaccess to credit.
Fiscalía Nacional Económica and the Competition Tribunal. Enforce respective institutional responsibilities anduse rigorous economic analysis in ruling on cases involving uncompetitive policies. Consider allowing theTribunal to dismiss cases that are not well justified by the plaintiff.
Innovation
Remaining challenges
Define and Intensify a nationalstrategic vision for technologicalprogress
Strengthen capacity in Science andTechnology
Key policy poptions
Options include measures to: (i) consolidate and review initiatives to increase the public and especially theprivate adoption of technologies that will consolidate TFP growth; (ii) enact the “Consejo Nacional de Innovación”bill that will facilitate medium run policy goals and coordinate existing institutions and public funds towards theachievement of those goals; (iii) establish an institution with strong private sector participation that caneffectively coordinate initiatives across sectors; and (iv) develop a coherent set of incentives and initiatives forprivate sector innovation and capacity building and strengthen processes for the evaluation of programs andthe prevention of duplication. Mining tax revenues could be gradually channeled towards increasing theR&D/GDP ratio in the medium run, subject to extensive evaluation.
Options include measures to: (i) review the S&T dimensions of the National Innovation System-universities,public and private research institutions and supporting institutions; (ii) define the mission of nationaluniversities and align policies to promote excellence and to foster collaboration with the private sector; (iii)evaluate ongoing programs for competitive funding and centers of excellence and strengthen them if merited;(iv) strengthen incentives for outward orientation; and (v) provide better information on the certified quality ofuniversities and on the achievements of their graduates in the labor market. PRIs would benefit from a globaland individual evaluation to identify their current role in the NIS and to address market failures in the specificsectors they participate in.
52
Innovation
Remaining challenges
Address Educational and HumanCapital Shortages
Key policy options
Consider measures to increase the number of PhDs and evaluate the extent to which their specialization isoriented towards science and engineering. Evaluate current programs that foster collaboration betweenresearchers and firms and facilitate linkages with private sector through internships, mentoring, etc.
Education
Remaining challenges
Supervise and support schools toachieve expected results
Ensure equality of educationalopportunity
Improve the information available toparents and civil society on schoolquality
Education policy and programevaluation
Attract and retain qualified teachers
Key policy options
Under-performing schools would benefit from increased attention and supervision, while high-performingschools could receive increased autonomy and decision-making authority over financial and human resources.
Consider introduction of a student subsidy differentiated by student income level. For quality and equitypurposes, schools that receive the differential subsidy would be subject to eligibility requirements, wouldrequired to limit or eliminate unfair student selection practices, and would be held accountable for how theadditional resources are employed.
The State has an important role to play in ensuring that accurate, comparable information among schools ismade publicly available in ways that are easy to understand and are timely.
Systematic evaluations of education policies and programs would enhance the quality of current initiatives aswell as future reforms. In the project design stage, steps could be taken to collect information on a comparatorgroup as well as on the experimental group that is affected by the program.
Consider multi-year agreement with teachers to secure participation.Evaluate improved incentives through changes in the salary structure.
53
Social protection
Remaining challenges
Social assistance
Income risks from health costs
Key policy options
Complete a rigorous evaluation of Chile Solidario.Examine more proactively the role of OMIL in job search assistance, starting with the beneficiaries of ChileSolidario, and drawing from experiences of the UK and US.
Evaluate possible further moves toward financing the Plan Auge from general taxation.
Financing development
Remaining challenges
Identify fiscal impact of medium-and long-term development needs
Fine-tuning the tax system toimprove efficiency and equity
Improve implementation of fiscalrule
Long-term financial arrangements
Key policy options
Comprehensively evaluate the fiscal impact of the current and projected medium-and long-term demand forsocial transfers, including contingent liabilities.
Tax system:Consider conducting a survey of tax compliance.Review the case for VAT exemptions and special rates.Consider eliminating high-distortionary taxes such as the stamp tax.Ensure that market prices reflect externalities by levying a special tax on diesel cars.Consider reducing the (35 percent) additional tax on dividends.Consider reducing the number of brackets and marginal tax rates.Consider eliminating some credits, deduction and exemptions to improve equity and simplify the tax system.
Consider extension of the role of automatic stabilizers, improvements in the consistency between forecasts ofGDP and copper prices, and reduction of the variability of fiscal policy in any one fiscal year.
Consider establishing a target for Government debt rather than one derived from the fiscal deficit. Internationalcapital markets look at the stock of debt outstanding rather than the flow. Assess options in international capitalmarkets-like equity swaps-to hedge risks that have hurt Chile's budget and economy in the past.
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