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Saturday, April 25, 2009

Chile, a Rare Success Story?

By Claus Vistesen: Copenhagen

Yes, I know. Everybody is talking about a recovery and how the worst is over and investors are still bathing in the soothing calm of longest bear rally so far in this crisis. But seriously, you don't believe that this will last do you? Well, even if you do, this will not be the topic of this entry [1].

Rather, I thought it would be interesting to have a look at one of the (relative) success stories in the midst of the economic mire in which we find ourselves. The economy in question is Chile, and apart from Bloomberg's report that Finance Minister Andres Velasco, after having been "burned" back in November, is now almost a rock start the point is well worth pondering.

(cut and paste at my discretion)

The Chilean peso has risen almost 10 percent against the dollar this year to become the best-performing currency among emerging markets. The country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund. While Chile stashed away copper profits, neighboring Argentina boosted spending when revenue from soybean exports rose, leaving it short on cash to stimulate the economy this year.


Velasco set up funds to invest the copper windfall abroad, mostly in government bonds. He announced plans to spend the interest from savings on scholarships and helped Bachelet extend social security to 1.3 million people. In his first three years in office, Velasco posted the biggest budget surpluses since the country returned to democracy in 1990. In 2007, Chile became a net creditor for the first time since independence from Spain in 1810.

Last July, copper reached a record of $4.08 a pound. By year-end, the central bank had built $23.2 billion of reserves. The government had $22.7 billion in offshore funds and about $2.8 billion in its own holdings.

After Lehman Brothers Holdings Inc.’s Sept. 15 bankruptcy sparked a global credit freeze, Velasco and De Gregorio had the equivalent of more than 30 percent of GDP available if needed to shore up Chile’s banks and defend the peso. The price of copper plummeted 52 percent from Sept. 30 to year-end, and Velasco dusted off his checkbook. In the first week of January, he and Bachelet unveiled a $4 billion package of tax cuts and subsidies. “He has been vindicated,” said Luis Oganes, head of Latin American research at JPMorgan Chase & Co. in New York, who studied under Velasco.

The story about the copper windfall in Chile is a remarkable story really and as I reported in an extensive review of the economy back in October Chile's government went into the crisis in the rare role as a net credit with debt to gdp at -11%. Moreover, I have also shown how Chile has managed to wield the benefits of the demographic windfall (the demographic dividend) rather well.

If we look at some indicative economic evidence it does indeed seem as if Chile is the odd man out in Latin America with the Peso performing somewhat better than the main benchmark (according to me) in the form of the Brazilian Real as well as the markedly lower increase in sovereign debt spread due to the crisis.

So, I guess the question is then. Should you invest in Chile? Clearly, Chile is also like most other countries currently in a recession, but then again why not? I hold that Chile is one of the best opportunities to pick up a decent return in the context of an otherwise rather rugged emerging market edifice. But then again, I am not an investor.

[Disclosure for Seeking Alpha: No positions]


[1] Although please do retort in the comments section. And RP, you can bugger off!

Sunday, October 5, 2008

Chile's Economy In Perspective - October 2008

Chile Country Outlook

Claus Vistesen: Copenhagen

Executive Summary and Outlook on key indicators

There are many lenses and perspectives through which to look at economic development. In this note, the process known as the demographic dividend is conceptualized in a Chilean context. The analysis shows how Chile during the past two decades has benefited from the dividend proxied by the increasingly favorable trend in overall age structure of the society. By some measures Chile’s demographic dividend is ending in these very years, but by adapting a slightly broader definition of the optimal working age and subsequent productivity profile it appears that Chile still finds itself in the proverbial sweet spot. Coupled with the favorable windfall from copper exports and the subsequent transformation of this into an unprecedented net wealth position of Chile’s public accounts, the economy looks on a very solid footing to face whatever travails which might come next.

As for the immediate outlook for Chile it appears that a slowdown is steadily rolling its way in. Tightening credit supply by financial institutions, a hawkish central and deterioration in terms of trade (forecast by the central bank) are all factors to be taken into account. Finally, a slowdown in the economy’s rate of job creation rate suggests that the slowdown may now finally be set to take hold in the immediate future. Consequently, headline GDP is expected to moderate somewhat in H02 2008 and H01 2009.

Chile has benefited immensely from the global boom in commodities and specifically the surging price of copper. The revenues from copper exports have kept Chile’s external trade balance solidly in the black for he past 4 years and the subsequent windfall have provided Chile with bulging coffers in the treasury. Official forecasts suggest that this may now be about to end, but it needs to be stressed that as long as copper prices stay in the region of the current level and absent a complete slump in demand, the trade balance should continue to provide a sound counter balance to the negative income account.

As is the case in most other emerging economies the Chilean central bank is strongly focused on an inflation rate currently running well above its 3% target (9.5% in July). With this in mind, it is reasonable to expect that the central bank will continue to raise to a policy rate of 9.5% before the end of 2008. Coupled with the recent suggestion by official advisors that the central bank abandon open market operations to manipulate the Peso, the hawkish position should benefit the Peso in H02 2008. One risk to this call would be a significant spike in risk aversion that could lead to an emerging economy wide capital flight.

An Orderly Slowdown Ahead

The Chilean economy continued to expand in Q1 albeit at a slightly lower pace than in 2007. GDP growth expanded 3 % on the year and 1.4% q-o-q where the latter figure translates into an annualized growth rate of 5.6%. Not many forecasters, official as well as commercial, expect this figure to hold however. Morgan Stanley recently revised its 2008 GDP estimate downwards from 4.3% to 3.8% whereas the central bank is more sanguine in their bid of 4.0 to 5.0% for 2008. Chile expanded 5% in 2007.

On the demand side the expansion in Q1 was largely driven by gross fixed capital formation. For 2008 the central bank is predicting investments to increase by 13% driven, to a great extent, by energy and mining related capex. Consumption however grew at an overall slower pace than 2007 and is not expected to top a 5% growth rate in 2008. As for government spending, the central predicts that the formal rule established in light of the recent copper bonanza (see below) will persist in 2008 where the public surplus is expected to clock in at 0.5% of GDP.

Despite the apparent solid performance figures signs are emerging to indicate the Chilean economy may be slowing. This possibility is hinted at in the recent central bank monetary report where a decidedly cautious tone is presented. The central bank ascribes a relatively high downside to the effects from incoming inflation pressures as well as negative hydrological conditions which are tantamount to the energy supply in Chile.

One sign that the economy may be entering a softer patch comes from industrial production figures where production fell in both April and May at -2.8% and -0.9% (m-o-m) respectively. If we turn to yearly figures, the recent months have been more volatile than the stable levels observed in 2006 and 2007 but the trend is inexorably one of decline. Over the first six months of 2008 industrial production averaged a 4.2% increase which compares to an average of 5.2% in the corresponding months of 2007.

Domestic demand as proxied by sales of consumer goods also shows signs of decline in growth rates. In the first half of 2008 sales averaged a monthly (y-o-y) growth rate of 4.2% which compares with 7.7% in H01 2007 and 5.0% in H02 2007. An educated guess suggests that domestic demand will grow in the region of 3.5% to 4% in 2008 which must be compared to a corresponding growth rate of 6.3% in 2007. Clearly, this does not signify a crash, but more so a moderate slowdown in line with global fundamentals. Morgan Stanley’s in-house Chile analyst Luis Arcantales also weighs in on the situation of the consumer. Arcantales notes three headwinds in the form of rising inflation, tightening credit standards, and a slower job creation. According to Arcantales the banking sector in Chile has acted swiftly, and in essence proactively, in the face of the global outlook where tighter credit standards seem certain to be a part of the equation. In the second quarter of 2008 44% of banks consequently reported that they have tightened credit standards. If we add the fact that the central bank of Chile is still in the midst of a hiking cycle, which so far as taken the rate to 7.75% from 5% in June 2007, it is clear that demand and supply for consumer credit is likely to fall further.

With respect to labour market dynamics employment continued to expand briskly in Q1 2008, but seems to have slown down somewhat in Q2. Out of an estimated 7.186.130 people in the labour force 6.583.130 were in employment which translates into an unemployment rate of 8.4% (603.000). In Q2 the number of people in employment furthermore decreased slightly 0.3%. Compared to Q2 2007 the unemployment rate increased 1.5% and compared to Q1 the corresponding figure was 0.4%.

This coupled with a hawkish central bank and a deteriorating credit environment for consumers suggests that Chile may be heading down a notch a two when it comes to top line economic growth.

Inflation is creeping up

As a part of the general slowdown in economic activity the lingering increase in inflation definitely seems to be the most pre-occupying threat from the point of view of policy makers and sell side research.

JPMorgan suggests that Chile may be set to enter a stagflationary phase as growth nudges below trend at the same time as inflation remains elevated. JPMorgan furthermore anticipates the central bank to move in strongly to counter the inflation trends which will further put pressure on Chile’s economy.

Unlike in other economies inflation pressures do not seem to come as quickly on the back of easing commodity pressures as first expected. In July, inflation rose to an annual rate of 9.5% and even though the central bank opted to raise interest rates 50 basis points on the 14th of August the real interest rate is still negative. This may not in itself be a solid policy gauge since, as we learned above, credit already seems to be tightening considerably due to restraints on the part of a proactive financial services sector. At this point, inflation forecasts for 2008 are hovering between 8-9% and with a formal target of 3% we can expect the central bank to continue with the rating cycle. The central – confident in its investment strategy, forecasts that inflation should fall towards its 3% target in Q2 2009.

We are reluctant to look this far ahead but concur that inflation is set to remain high for the rest of 2008. This, in turn, will in turn keep the central focused on inflation. It is thus perfectly possible that we see a central bank refi rate of around 9.5% before 2008 is out.

One important factor here is also the Peso where the central bank has recently been engaged in open market operations to stem the flow of appreciation against the USD and in fact to maintain what has been a steady depreciation since April.

Given the inflationary tendencies and their persistence advisors close to the central bank have explicitly suggested that such open market operations be abandoned due to the threat from inflation. Given the recent and new found strength of the US dollar it is difficult to say whether the Peso will be flattered too much by the central bank’s hawkish stance (against the USD that is). However, it is reasonable to expect we think that the Peso will appreciate moderately provided that the central bank decides to stop its open market operations. At the end of June the Peso marked a 10 year low against the Dollar, a value we feel should fall slightly in H02 given the continuing hawkish position by the central bank.

Copper, Copper Everywhere

Perhaps the most important aspect of the Chilean economy since the advent of the 21st century has been the extraordinary windfall from copper production and exports. According to most estimates Chile alone accounts for one third of the world’s copper production and in light of the relentless upward March of copper prices Chile has seen its goods trade surplus swell accordingly.

In formal terms, the so-called copper Bonanza began in 2004 and has continued un-abated up until this point. Given the recent decrease, across the board, in basic commodities the goods trade balance seems set to deteriorate but only slightly as far as goes 2008. In Q1 the goods balance stood at 6231 mill USD which is up considerably from the previous quarter. In Q2 and Q3 the goods balance is forecast [1] to take the value of 6555 and 6147 mill USD respectively where the trend is more important than the point forecast itself.

However, the external balance is not only about tangible goods.

Consequently, and while a positive trade balance is still keeping the overall current account in surplus, a negative income balance is beginning to pull the trend down. Add to this that the trade balance in 2008 looks set to be weaker than in 2007 the current account could very well swing into negative in 2009 which would be the first time in five years. In fact, the central bank is predicting the current account to swing into negative already in 2008. This seems a quite bearish forecast but much will depend on the rate of import growth which is the major determining factor in the forecast. As such, the central bank forecasts the goods balance to deteriorate to 17.000 mill USD in 2008 from 23.653 mill USD in 2007. Clearly, this would be at odds with the model deployed above but given its high degree of prediction error in terms of point forecasts, the central bank’s forecast should not be explicitly challenged at this point.

Much more important than the immediate outlook of the external books is, however, the way Chile has chosen to manage the recent years’ copper bonanza. One crucial aspect to note is then the extent to which Chile has maintained fiscal discipline in the face of the surging commodity boom. In numbers, Chile has consequently aimed at an annual fiscal surplus of 0.5%/GDP to act as a counterweight to the incoming copper revenues. In more traditional economic terms one could also see this as a proactive attempt to avoid that Chile fall under the yoke of a Dutch disease type correction.

So far, Chile has honed up to its intentions.

Between 1996 and 2006, Chile’s public balance averaged 1.5% of GDP a position much better than that held by its peers in East Asia and Latin America. From 2005 to 2007 the structural surplus as a percentage of GDP was 1% and is expected to 0.5% in 2008. However, the pure fiscal surplus, in 2008, as a percentage share of GDP stood at 8.1% which is quite extraordinary on any measure. In 2008 the corresponding figure is set to decline to 4.8% which still represents a solid cushion.

Apart from handing Chile the highest sovereign debt rating in Latin America it also prompted Luis Arcantales recently to dub Chile the real thing referring to the fact that Chile, unlike its Latin American peers, has chosen to build up a structural fiscal war chest rather than one of foreign FX reserves. Ultimately however and a in a context of global liquidity the bottom line remains much the same. Consequently, Chile’s treasury recently laid out a plan on how to construct an optimal global portfolio from which the copper windfall could be transferred into financial assets. Through the so-called Economic & Social Stabilization Fund (FEES), Chile plans to put a substantial amount of its savings into equities and corporate bonds. Thus, and quite in line with other sovereign investment vehicles (SWFs), so will Chile’s savings also be going for yield, even in a situation where the government is a net creditor with outstanding debt at about -11% of GDP.


[1] This is how our model performs in a post mortem perspective.

In general, the fit in terms of point forecasts is not that good, but the fitted trend is very close to the actual movements with a correlation coefficient of 0.92. From a standard model selection criteria point of view the model performs marginally better at predicting the trade balance than a random walk model although it is considerably better to predict the time series in changes. The model is consequently formally built upon variables in changes to correct for stationarity problems.

List of References

Arcantales, Luis: Morgan Stanley GEF - Can’t Beat the Real Thing! 18.03.2008
Arcantales, Luis: Morgan Stanley GEF – Dark Clouds for the Consumer 20.08.2008

Friday, September 5, 2008

Chile Central Bank Raises Interest Rate

Chile's central bank raised its target interest rate to 8.25 percent, the highest in almost a decade, as policy makers show their determination to win the fight against inflation. The bank's five-member board, led by President Jose De Gregorio, is trying to contain consumer price increases that are triple its target. The bank said today that the speed of further rate increases depends on economic statistics, dropping a clause from last month's statement that said raising the rate is the ``most likely'' scenario.

``The future course of the policy rate foresees further adjustments to ensure that inflation converges with the target, at a rhythm that will depend on new information gathered and on its implications for projected inflation,'' the bank said in its statement.

Inflation last month was within expectations, the bank said. Core inflation, which excludes food and fuel, remains high, confirming that price increases have spread through the economy more quickly than policy makers expected a few months ago, the bank said. The bank indicated that it felt that domestic demand is still growing strongly.

Inflation reached a 13-year high of 9.5 percent in July. It eased in August to an annual rate of 9.3 percent, more than triple the bank's target of 3 percent. The bank has raised interest rates by 6.5 percentage points in the past four years and 2.75 percentage points in the past 12 months. So far the rate increases haven't slowed Chile's economy, which expanded 6.25 percent in the 12 months to July, the fastest pace since March 2007.

The bank also stated that the data they had suggested the economy will grow faster in the second half of the year  than it did in the first. The bank is due to announce new projections for growth and inflation on Sept. 11.

Annual core inflation, which excludes fuel and perishable food, was 9 percent in August -  the fastest since the institute started tracking the figures -  and this was for the second month in a row. 

Sunday, August 31, 2008

Economic Growth in Chile

By Claus Vistesen: Copenhagen

There are many perspectives through which to look at economic development and growth. Geography, institutions or perhaps just plain good old physical capital accumulation are all important parameters. This small piece suggests a further metric and attempts to frame the argument with Chile as a case study.

Specfifically, this note explains the process known as the demographic dividend and conceptualizes it in a Chilean context. The analysis shows how Chile during the last two decades has benefited from the dividend proxied by the increasingly favorable trend in overall age structure of the society. By some measures Chile’s demographic dividend is thus ending during these very years. Yet, by adapting a slightly broader definition of the optimal working age and subsequent productivity profile, it appears that Chile still finds itself in the proverbial sweet spot and will continue to do so for the next decade. Coupled with the favorable windfall from copper exports and the subsequent transformation of this into an unprecedented net wealth position of Chile’s public accounts, the economy looks on a very solid footing to face whatever travails that might come next.

A Good Run

As can be observed below, Chile did indeed lose a substantial amount of output surrounding the Latin American debt crisis in the 1980s as well as the Asian currency crisis in 1997. Yet, and although Chile’s economy did not emerge unscathed from the past three decades of emerging market crises, the economy still managed to recover in terms of output. [1]

Chile's growth performance depicted by the chart is interesting in so far as it shows us the period that some scholars have dubbed Chile's Golden Age (Gallego and Loayza, 2002) due to the extended period of high growth rates. Between 1984 and 1998 Chile's growth rate in output per capita averaged 5.15% a year with a volatility of 2.64% p.a. This compares with an average growth rate in output per capita between 1998 and 2008(f) of 2.61% and a subsequent volatility of 1.73%. The 1985-1998 figures are remarkable and thus deserve some explanation.

According to Gallego and Loayza (2002) Chile's impressive growth performance primarily comes down to improvements in total factor productivity induced by increased investment in human capital and the development of a sound and coherent institutional setup. As such, and not unlike other growth accounting exercises the authors initially find that TFP accounts for the biggest share of output growth alongside the usual suspects of capital accumulation and growth in the labour force, the latter which is (in)famously coined as synonomous with population growth in the neo-classical growth model

The empirical approach is rather straight forward in terms of methodology, and is closely related to the tenets of endogenous growth theory as well as of course Mankiw, Romer and Weil's (1992) seminal findings that investment in human capital be considered an important part of capital accumulation. Formally, the authors first estimate a cross-section regression framework (GMM) based on a, more or less, standard neo-classical growth model augmented with human capital (schooling rates and life expectancy). The authors also include; government consumption to GDP, financial market development, terms of trade shocks, trade openess, and a black market premium. They find that this model account for 43% of the growth observed in Chile.

Unsatisfied with this result, the authors imbue the model with a number of variables whose origin in the growth theory framework are inspired by the tenets of endogenous growth theory. These variables include proxies for the political system, governance, public services and infrastructure, and with these, the new model moves reaches a coefficient of determination of 73%.

In line with endogenous growth theory the authors consequently find that this initial "residual" best be explained by improvements in the institutional edifice of Chile's economy. As a result and although the notorious convergence effect will tend to lead to lower overall growth rates in period t0 than in period t-1, the authors suggest that Chile focus further on institutional improvements to foster growth in the future.

Far be it from me to take issue with these results. However, in the following I propose another way to look at the past and future growth performance of Chile. It is important to understand that the two approaches are not mutually exclusive but ultimately directs the attention to a different set of governing mechanisms when it comes to economic growth.

A Demographic Dividend?

In one of their many papers on the subject David E. Bloom and David Canning (see Demographic Challenges, Fiscal Sustainability and Economic Growth, PGDA Working Paper no. 8) provide a useful historical sweep of the different approaches to demographic changes and their significance on the economic edifice. From the Malthusian epoch to a more optimist view on the benefits of vibrant population dynamics (see e.g. Simon Kuznets, Julian Simon, and Ester Boserup) and on to what Bloom and Canning coin as the “neutralists” [3] , the perspective on the importance of demographics has certainly changed a lot.

One crucial lesson to draw from the historical prism of demographic discourses is that the demographic transition is a far more complicated process than a mere transition in population growth rates as well as one of sectoral shifts in the economy. Lee (2003) consequently shows how the demographic transition also fundamentally changes the age structure of society whereas others such as Malmberg and Sommerstad (2000) and Hugh (2006) have suggested that the demographic transition be re-thought all together. Common for these contributions is the shifts in age structure, the complex mechanisms which govern these changes, and their subsequent effect and operationalization on the macroeconomic edifice.

Bloom, Canning and their fellow scholars on the PGDA at Harvard, [4] have furthermore showed how age structure makes a much more solid demographic yard stick, for gauging economic trends, than merely looking at population growth and absolute size of the population. This, I think, is the ultimate lesson to derive from decades worth of thinking on demographic processes. I would essentially divide the lesson into two irrefutable points. One is that age structure matters much more than population growth and that a simple metric such as median age can give us a tremendous amount of information on an economy's given and future growth path. The second points is simply that the demographic transition is not, by a long shot, over. In fact, nobody knows when it will end.

It is within this framework that the process known as the demographic dividend enters, and not surprisingly, it is all about age structure and how economies who go through the demographic transition at some point will find themselves with above average conditions for growth as the working age as well as productive share of the population is maximized. In terms of median age and as a crude benchmark, we can say that those economies with median ages between 25-35 are situated in or close to the optimal age structure for economic growth. Nothing comes for free however, and it is crucial to point out that the demographic dividend provides an opportunity rather than a sure benefit. For example, it seems that Eastern Europe and Russia, by and large, have gone through their demographic dividends without experiencing the corresponding win-win situation in which favorable growth conditions coincides with advances in terms of institutional quality and political stability.

The demographic dividend operates through two interconnected mechanisms in the form of falling fertility and declining infant mortality. In most countries, falling mortality as the economy moves through the demographic transition has been accompanied, with a lag, by falling fertility Bloom and Canning (2006). If we add a steady increase in life expectancy to proxy the general improvement in the health of the population these interconnected processes endow an economy with a period of, let us say, 15-20 years in which the young and working cohorts of the society are relatively big compared to the dependent cohorts. The former are often defined as the cohorts aged <20-25 [5] years and for the latter's part >65. As for quantitative importance, Bloom and Canning (2004) have shown this to have a positive effect on per capita output as well as they have famously shown how one third of the East Asian Tiger economies’ impressive growth spurt in the latter part of the 20th century can be explained by the demographic dividend.

More generally Bloom & Canning et al. (2007) have also demonstrated, through cross sectional regression data, how age structure can significantly improve the forecast of economies' growth rate relative to world GDP.

Chile’s Demographic Dividend

If large parts of East Asia have already had their demographic dividend what about Chile then. Is Chile about to receive, or more aptly; is she in the middle of her demographic dividend?

As can readily be seen, Chile almost displays a textbook case of economic development. In this way, infant mortality has fallen back sharply since the middle of the 1970s as well as life expectancy has increased. Outside the immediate realms of economics, biologists and health economists speak of the process known as the epidemiological transition to explain the progression of the change in (and drivers of) variables such as mortality, life expectancy, and other public health metrics.

The reduction of, and subsequently the current level of, infant mortality in Chile rivals that of many developed economies. According to Albala and Vio (1995) Chile managed to reduce infant mortality by 82% between 1970 and 1992 and Jimenez and Romero (2007) further shows how provisions of services to counter perinatal risks and acute respirator distress have helped Chile to reach an impressive infant mortality rate of 8.9 infants per 1000 thousands in 2000.

With respect to life expectancy Albala and Vio (1995) describe how the mortality rate of people aged 65 and more decreased 73% between 1970 and 1992 . Especially, a reduction in the mortality from cardiovascular causes is highlighted. In a more recent paper Albala, Vio et al. (2002) also latch on to increasing risk posed by a transition from a prevalence of infectious diseases to on in which chronic diseases ascend in importance. The usual suspects here would be an increase in obesity as a result of malnutrition through the consumption of high-fat/high-carbohydrate energy-dense foods and a decrease in physical activity. Chronic diseases which spring from such developments would then be e.g. type 2 diabetes and cardiovascular diseases. Evidence of this development appears in the context of school children; from 1987 to 2000 the prevalance of obesity among first grade school children rose more than 100% for both boys and girls.

Much debate has and will be devoted to the extent that such adverse developments from economic development could, at some point, break the curve in terms of life expectancy. At this point however, it seems as if advances in healt care services and the subsequent improvements in old age life expectancy are enough to keep the curve ticking upwars.

Returning to the question of demographic dividend in Chile, the trend of the decline in infant mortality exhibits the expected negative concave relationship as per function of the fact that the value cannot fall below 0. In order to build a simple model framework and by applying the logic expressed through theory above, we can construct a rudimentary econometric model to formalize the argumet.

Consequently, we let the lagged change (one year) [6] in the infant mortality rate predict the change, in year 0, of the fertility rate. Given the properties of the time series in question, and the theoretical framework above we would expect a positive but also a concave relationship since both variables are bound by the fact that they cannot fall below 0. In general terms, this model clearly assumes that the process of decline in fertility throughout the demographic transition is infinitely simpler than it really is. The crucial point here is that while the decline in infant mortality may be able to explain the decline in fertility on a certain part of the curve it cannot, and may in fact see its sign reverse, as we move further towards replacement level fertility and beyond. One could even with reasonable claim ask whether in fact the decline in fertility towards replacement levels is driven by infant mortality reductions alone. Nevertheless, the model estimated looks as follows where both variables are in changes.

Which leads to the following estimation:

The visual inspection of the model can furthermore be derived from the graph below.

In general, the model is far from solid but it manages to get the message across in the sense that it links the decline in fertility to the lagged decline in infant mortality [7] . The key thing to remember is the implicit and theoretical concave relationship cited above; a relationship also confirmed by the scatter plot.

The interesting thing about Chile here is that, according to standard demographic theory, the demographic transition should, by and large, end now as fertility trends towards replacement level. Not a lot of serious scholars would believe that however and we can thus expect fertility to decline below replacement level (see e.g. Wolfgang Lutz here). The extent to which it does not, Chile would clearly constitute something of a remarkable case. This is also why policy makers would be wise to consider implementing steps to avoid fertility dropping into lowest-low territory [8] , since what we know with almost certainty is that the demographic transition does not stop once infant mortality hits near rock bottom.

This point also highlights the idea that while the demographic dividend presents a window of opportunity so does the backdrop represent a penalty. This point is crucially related to the fact that only very few economies (e.g. the US and perhaps also France) have been able to stay at, or return to, replacement levels of fertility. In most other cases, fertility seems set bound to fall further and the only real metric to gauge is the speed by which this occurs. In an emerging market context the evidence is worrying to the extent that many economies have seen their fertility rates crash completely over the course of less than a decade. The next 5-10 years in Chilean, and indeed Latin American context, will be extremely interesting to watch in this regard.

Given the fact that Chile's fertility level is already approaching replacement level, the model cited above has, in all likelihood, run its course. What will likely cause Chile's fertility rate to fall below replacement level requires an entirely different set of explanatory variables and also theoretical edifice. Key trends would for example include an elaboration of the quantum and tempo effect of fertility in a context of rapid economic development and changing social norms.

To summarize the argument in a Chilean context, the ultimate data series to gauge, in the context of the demographic dividend would be age structure and the effect from the processes described above.

As per usual, beauty is in the eye of the beholder since depending on which definition you ascribe to the optimal age structure, Chile could be said to be in and out of the demographic dividend. The truth probably is that Chile is in the twilight hours of its demographics dividend. However, with a median age of about 30 years Chile still enjoys, and will continue to do so in the immediate future, the benefits of an age structure conductive to balanced economic growth.

One important point to note here is that the 25-44 bracket peaked sometime in the middle of the 1990s. Much evidence suggests though that it is a bit untimely to make the cut at the 44 year old age group, since many people are perhaps not far from their productive peak between 44 and 64. On the other, the peak of the 25-44 age bracket may still constitute an upper level of economic capacity if viewed as the ability and propensity to sustain housing booms, large negative external balances etc.


Chile still has ,and will continue to enjoy for the immediate future ,a favorable age structure for harboring economic growth and dynamism. Favorable is in this context defined through the spectrum of the demographic dividend and the subsequent increase in, and high proportion of, working age people to total population. Depending on fall in fertility, the demographic dividend is definitely tapering off at this point. If experience from East Asia is anything to go by Chile as well as its Latin American peers are now set to enter a new phase of the the demographic transition in which fertility steadily moves below and beyond replacement levels. The speed here is crucial. If it happens slowly, Chile can expect to posses a relatively balanced age structure in the decades to come but if the decline is swift and lingering the effect could be otherwise.

This small piece has also touched upon the way we conceptualize economic growth and development. I would not want to discount methods such as the one deployed in Gallego and Loayza (2002). However, I have suggested that a different perspective is a also considered. I would, in particular, emphasise this in the context of the future drivers of economic growth. Nobody can disagree with the impetus to move forward on strong institutional settings. Yet, economic development is not only accompanied by a demographic dividend but also, arguably, a demographic penalty which occurs as the effect of the dividend recedes and the decline in fertility continues. This would be where concepts such as the quantum and tempo effect of fertility comes in. it is also where policy makers would be wise to consider that a relentless strive to reach the apex of the value chain will also bring with it a deficit in terms of the proper quantity/quality mix of human capital.

List of References

Albala, Cecilia; Vio, Fernando; Kain, Juliana and Uauy, Ricardo (2002) - Nutrition transition in Chile: determinants and consequences, Institute of Nutrition and Food Technology (INTA), University of Chile

Albala, Cecilia and Vio, Fernando (1995) - Epidemiological transition in Latin America: The case of Chile, Institute of Nutrition and Food Technology (INTA), University of Chile

Bloom, D and Williamson, J (1998) Demographic transitions and economic miracles in emerging Asia. World Bank Economic Review. 12(3) 419-456.

Bloom DE et al. (2007) - Does Age Structure Forecast Economic Growth? PGDA Working Paper no. 20.

Bloom, DE & David Canning (2006) – Demographic Challenges, Fiscal Sustainability and Economic Growth, PGDA Working Paper no. 8.

Bloom, DE and Canning, D (2004) - Global demographic change: dimensions and economic significance, In Global demographic change: economic impacts and policy challenges (proceedings of a symposium, sponsored by the Federal Reserve Bank of Kansas City Jackson Hole)

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[1] Although Chile did not recover from the Asian currency crisis to pre 1997 levels.

[2] Bloom & Canning (2006) – Demographic Challenges, Fiscal Sustainability and Economic Growth, PGDA Working Paper no. 8.

[3] Basically, this would be the modern institutional paradigm that has emerged within the economic growth/development discourse (see e.g. Daron Acemoglu, Dani Rodrik and Amartya Sen).

[4] See numerous contributions here: http://www.hsph.harvard.edu/pgda/working.htm

[5] I would argue that this is the right threshold (unlike the <15>

[6] The time series are in changes to correct for non- stationarity. As for the lag, the optimal number of lags could be more rigorously verified on the basis of theory and the statistical properties of the time series in question (VAR)

[7] Although, as can also be observed in the graphs, it cannot predict sudden reversals in fertility trends; i.e. these would essentially be treated as exogenous shocks to this model.

[8] A TFR of <1.5

Thursday, August 28, 2008

Chile Industrial Output Still Rising Slowly

Chile's industrial production rose less than expected in July after shrinking in the two previous months. Output expanded 3.0 percent in July from the same month a year earlier, the National Statistics Institute said today in Santiago.

Industrial sales rose 2.1 percent in the same period, less than median estimate of seven analysts for a 4.1 percent rise. According to a separate release Chile's jobless rate was unchanged at 8.4 percent. The peso strengthened for a second day, rising 0.8 percent to 515.75 per dollar at 9:44 a.m. Santiago time.