Chile’s constitutional reform risks radicalization

Since its return to democracy in 1990, Chile is one of the great success stories of Latin America in the political, economic and social sphere. Economic growth averaged 4.2 percent per year in the past 30 years, and poverty levels were slashed to single digits.

In recent years, however, Chile has experienced significant social unrest. Economic inequality, perceived lack of representation for indigenous peoples, “expensive” higher education and health care are some of the many driving forces. As a response, Chile has embarked on a rewrite of its 1980 constitution with the hope that it would “fix” some of the underlying inequities and extirpate the legacy of Augusto Pinochet. However, there are reasons to worry that the forthcoming constitutional referendum will dismantle basic economic fundamentals and put Chile on the wrong path.

In this case, the cure could be worse than the disease.

Chile has made incredible gains in the last 30 years. In 1990, close to 40 percent of the Chilean population lived in poverty, while 13 percent of the population lived in extreme poverty. Life expectancy hovered around 74 years, and the middle class made up 24 percent of the population. The country’s GDP was $33 billion.

Fast forward 30 years later, the poverty level in Chile had decreased to around 8 percent, while extreme poverty levels have fallen to around 2 percent. Life expectancy is now 80 years, and the middle-class makes-up close to 65 percent of the Chilean population (in 2015). In 2019, GDP was $279 billion.

In terms of its economic composition, in 1992 mining made up 6 percent of Chilean GDP, and mining exports in general accounted for about 50 percent of total exports in 1991. From 1990 until 2016, copper production has risen two and a half times, Chile is the number one copper producer and number two Lithium producer globally. Despite the large increase in production and exports, Chile’s mining sector today only contributes 10 percent to the country’s GDP, thanks to a diversified Chilean economy. Because of this progress, Chile joined the OECD, the exclusive club of free-market democratic countries that many countries aspire to join.

One way in which Chile has accomplished this diversification is through the economic and social stabilization fund (ESSF), which replaced the Copper Stabilization Fund in 2006 and helps reduce exposure to global business cycles as well as volatility from fluctuations in copper price and copper demand. Since revenues from the copper sector are significant, the fund ensures a more stable source of revenues for the state that are not subject to shifts in the global marketplace.

Another important component of Chile’s diversification strategy has been the privatization of the pension fund system. Singled out in opinion polls as the most critical issue for the protesters, Chile’s private pension system is one of the top priorities for reforms that advocates hope to change with the new constitution. The conventional pay-as-you-go pension system was replaced more than 30 years ago by a new approach in which IRAs similar to American 401ks were managed and run by private firms. The Administrators of Pension Funds (AFPs) manage $200 billion, building Chile’s capital markets and diversifying the economy in the country. Chile has also had to rely less on external sources of financing and has reduced Chile’s engagement with the International Monetary Fund to almost nothing. 

Yes, AFPs charge investors a fee for their services, a point of contention for many lower-income earners or those who work in the informal economy.

In response to citizen’s grievances such as these, a national plebiscite held last year asked whether a new constitution should be drafted. The “approve” side won with over 78 percent in favor, although the elections only achieved a relatively low 50.9 percent voter participation.

The country’s current constitution was passed under Augusto Pinochet’s authoritarian rule in 1980 and has outlasted Pinochet’s fall and the subsequent transition to democracy. To be sure, there are some aspects of the constitution that arguably need revising. For example, the original constitution reserved Senate seats for military personnel and directed 10 percent of Chile’s mining revenues towards the military budget.

Since the 1990s, however, Chile has accomplished an admirable transition to democracy precisely within the framework of the current constitution. The amendment process has proven particularly valuable to deepening Chile’s democracy. For instance, President Ricardo Lagos, from the center-left Coalition of Parties for Democracy, made various adjustments to the constitution in 2004, making it more democratic. Some of these included shortening the presidential term from six to four years and eliminating posts of some military appointed senators. In fact, the original 1980 constitution has been amended 19 different times, most recently in 2017. All of these changes happened without altogether scrapping the original document.

Concerningly, the delegates tasked with redrafting the constitution are unlikely to stop by removing the legacy “oddities.” They are intent on a full-scale reshuffling of the Chilean government, economy, and society. Independents and the Left combined will hold more than two-thirds of seats in the constituent assembly, giving them a supermajority and not providing a break on any temptations by the Left for sweeping changes.

Potential political overreach by the Left in this constitutional convention could very easily put Chile on the path of economic radicalism. Some of the dangers of this include risking the private pension system.

Another danger is mandating higher levels of social spending. The Brazilian constitution serves as a cautionary tale in this regard: It mandated high levels annual public spending, making reforms nearly impossible and leaving precious few resources for discretionary measures. In 2016, as Brazil’s budget deficit approached unmanageable levels, the Senate was forced to pass a constitutional amendment to cap public spending after various major credit agencies downgraded Brazil’s credit rating to junk status.

Additionally, there have been calls for nationalizing key industries, and investors are already showing hesitancy amidst uncertainty about the future of mining under the new constitution.  Nationalizing sectors such as copper, coal, or fishing, is confiscatory, an attack on basic property rights and creates uncertainty for potential investors.

The talk by constitutional assembly members of a total overhaul of the pension system, significantly higher levels of public spending, and nationalizing industries goes too far, and such moves would effectively make it far more difficult for Chile to be the investment location of choice in the Americas. Business investment could plummet, and poverty would increase. Over time, the sweeping nature of such changes could also lead to even more social unrest, and Chile could begin to follow the path of the worst performers on the continent, such as Argentina.

Chile is one of the United States’ most reliable partners in the Western Hemisphere, and it deserves more attention. We have not had a confirmed U.S. Ambassador to Chile for more than two years. This is not how we should treat our friends.

Multilateral organizations need to monitor the constitutional convention process as well. The International Monetary Fund, the World Bank and Inter-American Development Bank should be speaking out about the financial dangers of such dramatic reforms to one of the most robust and most stable economies of Latin America — one with which the U.S. has a free trade agreement.

Responsible change is welcome, but radical change is dangerous.

Daniel F. Runde is a senior vice president and William A. Schreyer chair in Global Analysis at the Center for Strategic and International Studies. He previously worked for the U.S. Agency for International Development, the World Bank Group, and in investment banking, with experience in Africa, Asia, Europe, Latin America, and the Middle East.