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Chile should boost ties with India, which is expected to increase demand for imports thanks to growth policies of new Prime Minister Narendra Modi, the author points out. (Photo: Twitter account of Narendra Modi)
Wednesday, June 18, 2014
Perspectives

Chile: Change of Focus

Instead of lamenting the tax changes that lie ahead, Chile should boost ties with India.

BY WALTER T. MOLANO

Heavily laden clouds hover over the wintry skyline of Santiago, mimicking the general mood of pessimism. The landslide election of Michelle Bachelet heralded the introduction of new wave of legislation that will transform the country.

The heart of the new measures consists of tax and education reforms that go hand in hand. The tax reforms consist of aligning corporate and personal income taxes. Many of the loopholes that were used by individuals to reduce their income tax bills will be eliminated, thus generating an estimated 3 percent of GDP or $8 billion in additional revenue. The higher taxes will primarily be used to overhaul the education system.

EDUCATION: MAKING IT WORSE

In addition to earlier reforms that expanded the use of government grants to fund higher education, the government is proposing radical changes to education at the primary and secondary levels. Chile's public schools are poor, despite being the most prosperous country in Latin America. For decades, the government has recognized that the key to its future development will be through improvements in productivity. This requires significant upgrades in education and infrastructure. However, a well-organized and militant teachers union has successfully blocked all attempts to reform the system. That is, until now.

Unfortunately, the proposed reforms may only make the situation worse. Approximately, 8 percent of Chilean students attend private schools, which offer top rate education. The rest is split between public and subsidized schools. The latter consists of institutions that are privately owned, but also use public funds. Tuition tends to be minimal, but families are willing to pay a little in order to offer their children a better education. The public schools are considered to be the worst. The problem is that the government hopes to use approximately $5 billion of the new tax revenues to buy out the subsidized schools and transform them into public schools. Therefore, the reforms may do more harm than good. The remaining funds will be used for improvements in the public health system and to help reduce the fiscal gap. The reforms will be implemented gradually in order to avoid having too much of an adverse impact on economic activity.

ECONOMIC SLOWDOWN

Unfortunately, the Chilean economy is already grinding to a halt. Declining copper prices, tighter consumer credit conditions and the hangover from the housing frenzy are producing constant downward revisions of economic projections. Most Chilean economists forecast a growth rate of 3 percent to 3.5 percent y/y GDP growth rate in 2014, but the economy will be lucky to end the year above 2.5 percent y/y. In April, the IMACEC index of economic activity expanded only 2.3 percent y/y, and it will be in a similar range going forward.

Moreover, a new sense of militancy and arrogance is being displayed by Bachelet and her leftist allies. With a strong majority in the two chambers of congress, all debate and discussion has been virtually eliminated. New bills are introduced and summarily passed, without giving the opposition much chance to voice their concerns. The left always complained of the arrogance of the right in earlier times, but they are demonstrating the same flaws. The tax changes and air of hostility towards the private sector has brought investment to a screeching halt, which only adds to the country's economic woes.

HOPE: THE NEW INDIA

Yet, there is a ray of hope for Chile and most of the emerging world. Most Chileans bemoan the slowdown in China, but few are noticing the revolution that is about to sweep India. The resounding election of Narendra Modi stands to turbocharge a country of more than a billion consumers.

The result could be similar to the process that transformed China. The modernization of infrastructure and the construction of new highways, bridges and rail lines across the subcontinent will push up the demand for commodities. India's GDP is similar to Russia and Brazil, but with five times the population. Therefore, the urbanization process that will take place as the country modernizes and grows will lead to a building boom that will be in line with what China saw during the last decade.

Therefore, Chile needs to change its focus. Instead of lamenting the tax changes that lie ahead, it may be time to start making commercial ties with Delhi, Mumbai and Bangalore and Hyderabad because a new commodity super cycle may be close on the horizon.

Walter Molano is head of research at BCP Securities and the author of In the Land of Silver: 200 Years of Argentine Political-Economic Development.  

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