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Productivity, Growth, External Shocks and Capital Inflows in Chile (1977-81): A General Equilibrium Analysis

This paper uses a computable general equilibrium model to analyze the growth path of the Chilean economy during the 1977-81 period. During thar period a comprehensive package of reforms was implemented wich includes liberalization of international trade and the removal of restrictive labor legislation. As a result of the reforms, Chile closely approximated a free market economy. At the same time, starting in February 1978, the exchange rate was used to bring down the rate of inflation. The net result of the liberalization-stabilization experience was large changes in relative prices and in the structure of production and demand. During 1977-81 the economy had unprecedented economic growth with declining inflation although, towards the end of the period, severe macroeconomic imbalances became evident and in 1982 Chile experienced an abrupt and severe recession.

Taking the real exchange rate as an exogenous policy variable, and using the observed levels of employment growth paths and foreign capital inflows, this paper compares model-generated growth paths with those of the economy. First, the benchmark simulation path is used to estimate the magnitude and pattern of growth and productivity change during the 1977-81 period. Next counterfactual simulations are used to asses how Chile’s economic performance would have differed if:

(a) external events had been different; and

(b) the profile of foreign capital inflows had been different. The analysis suggests that the macroeconomic imbalances that led to the crisis in 1982 were exacerbated by the large capital inflows and real exchange rate appreciation that resulted from the use of the exchange rate as a stabilization device.