Decision Time In Santiago

Chile has weathered a rough year. Now voters must choose a president who will lead them back to growth

It's only mid-November, but Globo Azul Managing Director Francisco Ramdohr is already full of holiday cheer. The air at his family's toy factory outside Santiago is heavy with the scent of freshly cut Chilean pine, as workers hustle to meet orders for Winnie the Pooh desks and other wooden playthings. Sales this year have stalled at $5 million, and the company is barely breaking even. But Ramdohr expects sales to soar at least 30% in 2000 as a weakening peso spurs exports to Europe and the U.S. and falling interest rates reduce borrowing costs. "We've had a rough time lately, but now our prospects are looking a lot brighter," says Ramdohr.

The same could be said for Chile itself. After more than a decade as Latin America's star performer, this narrow strip of a country and its population of 16 million suffered a sharp reversal of fortune this year. Low commodity prices, a lengthy drought, and policy missteps by the outgoing government of President Eduardo Frei are expected to shrink gross domestic product by 0.7% for 1999. The fiscal deficit could hit 2% of GDP--unusual for Chile, which typically logs surpluses. But the downturn seems to be ending. Prices for copper, Chile's top export, have rebounded after hitting a seven-decade low in March, and demand is strengthening in key markets like Asia. After four consecutive quarters of decline, the economy began growing again in the third quarter. Next year, economists expect growth of more than 5%.

SWEEPING. Nevertheless, the country's first recession since the early 1980s has exposed weaknesses in the so-called Chilean model--the mix of low import tariffs, tight-fisted fiscal policies, and pro-business labor and tax laws developed by the University of Chicago-trained economists who advised the military regime of General Augusto Pinochet in the 1970s. Despite a sweeping sell-off of state-owned industries and bold innovations such as a privatized pension system--copied widely from Mexico to Poland--Chile's economy remains highly dependent on commodity exports and burdened by an inefficient public sector.

How well Chile resolves these problems will depend largely on the outcome of its Dec. 12 presidential election. The leading contenders in the race are Ricardo Lagos, 61, of the ruling center-left Concertacion coalition, and Joaquin Lavin, 46, of the conservative Alliance for Chile. Both candidates vow that they will stick to Chile's basic model. But analysts believe that even small adjustments in policy could determine whether the country returns to the 7%-plus growth rates of the mid-1990s.

Of the two hopefuls, Lavin is more in tune with the needs of the local business community. His advisers favor reducing the tax burden on companies, cutting the 35% capital-gains tax, and lifting a ban on employee stock options. "With Lavin, we could have a bit more economic growth and investment, but the risk is that there might be more problems with labor," says Valentin Carrill, chief economist at Santander Investment Chile.

By contrast, Lagos, a moderate socialist, has good relations with the unions. The candidate supports expanding benefits for the 11% of Chileans that are unemployed. Yet he is also stumping for the opening of state-owned mining giant Codelco to private capital, most likely through the sale of minority stakes.

Still, Lagos' attempts to score points with Chile's unions could ultimately hurt companies. He has endorsed a bill that would reverse the labor reforms that have helped boost competitiveness in Chile. The legislation mandates industry-wide collective bargaining on labor contracts in place of the more flexible company-by-company negotiations that are now the norm. It would also prohibit employers from replacing striking workers. The national manufacturer's association, Sociedad de Fomento Fabril, maintains that the legislation weakens companies' bargaining power in contract negotiations and could add between 10% and 15% to the cost of investment projects.

LESS STARK. Now, the bill has become part of the political game. Though it has languished in Congress for years, in late November the government used a procedure designed for national emergencies to push Congress into voting on the measure urgently. The maneuver is a political tactic aimed at forcing Lavin and conservatives to choose sides over labor and thus risk alienating scores of voters.

On economic issues other than labor and taxes, differences between Lagos and Lavin are less stark. Both can be expected to press ahead with so-called "second-generation reforms," such as rationalization of the bloated and inefficient public sector. "The state needs one of those big consultants like McKinsey or Booz-Allen to come in and perform major surgery," says Jose Ramon Valente Vias, a director at the Santiago office of U.S. credit-rating agency Duff & Phelps.

Both candidates, too, will seek to stimulate exports, particularly of non-traditional products, from salmon to software. This would help reduce Chile's dependence on commodities, primarily copper, which now accounts for 37% of total exports, down from 80% in the 1970s. "We shouldn't demonize the fact that Chile exports raw materials," says Foreign Ministry Under Secretary Mariano Fernandez. "But we always have to look to export much more than that."

A pioneer in opening its small domestic market to competition, Chile has a single import tariff rate of just 10%. That is set to fall to 6% in 2003. So Chile's companies are likely to keep looking beyond the country's borders for new markets. In recent years, products such as fresh fish, wine, and fruit have become important cash generators. Exports of salmon and trout, most of which go to Japan, have surged from $159 million in 1991 to $800 million this year. Vina Concha y Toro, Chile's leading winemaker, exports $100 million a year and has achieved brand recognition in the U.S. and Japan.

Exporters received a boost in September when the Central Bank ditched its managed exchange-rate system and allowed the peso to float. In the previous decade, the currency had appreciated by 30% in real terms, making Chilean products less competitive abroad. Since the peso was floated, it has fallen 6% against the dollar. "We were living under an eclipse," says Roberto Fantuzzi, head of the Association of Manufacturing Exporters. The weaker peso is "allowing us to see again."

Foreign investors, meanwhile, can look forward to an end to Chile's controversial controls on capital. The Central Bank is expected to abolish the requirement that all foreign investment must stay in the country at least one year, regardless of the outcome of the presidential vote. The measure, designed to prevent "hot money" from quickly entering and exiting the country, has been credited with reducing volatility in local capital markets. But it has also deprived Chile of billions of dollars in new investment. "A lot of potential investors see the one-year requirement and pass on Chile," says Jose Manuel Silva, an analyst at Santiago brokerage Larrain Vial. The lifting of controls could spur a surge in the Santiago stock exchange next year.

As the campaign draws to an end, Lagos and Lavin are running neck-and-neck, according to polls. A run-off, which would be held on Jan. 16, is likely since neither candidate is expected to secure the 50% plus one vote required for a first-round victory. When the new President takes office in March, ordinary citizens and businesspeople alike will be expecting him to adopt policies to speed recovery. Watch for the Chilean model to get a needed upgrade.