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the

Journal

Policy. Research. Practice. 31 October 2015 Editor in Chief Lauren Cuddy Egbert Managing Editor Allison Bott Solicitations Manager Haley Behre Production Manager Nikolai Condee-Padunov Editors Daniel Amador Nikolai Condee-Padunov Eric Faulk Adam Morgan Rachel Phillips Forum Directors Eric Faulk Albert Lin Radio Directors Reema Singh Elizabeth Caniano

Volume 12, Issue 2 • Fall 2015

journal.heinz.cmu.edu

Peace and Economic Development in the Federally Administered Tribal Areas of Pakistan

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Nauman Afzal Afridi

The Federally Administered Tribal Area (FATA) of Pakistan is a volatile region with a unique history and culture. Low literacy rates, lack of economic activity, and religious and cultural barriers have kept this region underdeveloped for decades. Today, FATA is perceived as a breeding ground for terrorists which has led both the US and Pakistan to conduct military operations. Despite development efforts of the Pakistani government and international donor agencies like the United States Agency for International Development (USAID) and the United Nations (UN), the region remains underdeveloped. Additional measures need to be taken to improve economic conditions and eliminate existing terrorist threats. This study aims to evaluate the past efforts of the Pakistani government and other organizations to improve the situation in FATA. If the world hopes to achieve regional stability and truly combat terrorism, the development of FATA should be a priority.

Chile: Recommendations for Sustainable, Long-Term Growth

Patricia Stubel

Chile is often cited as one of the best, easiest places to do business in the world, and is frequently the top-rated country for business in Latin America. There are several reasons for this, including a recent history of sound fiscal policy and a long history of strong democratic institutions. This paper first examines Chile’s economic history, its recent economic policies, and long-term concerns for growth. The second section examines the industrial and tax policies that make Chile’s business climate attractive to foreign investors. The paper concludes with policy recommendations for both Chilean industries and policymakers to foster long-term growth. These recommendations include minor adjustments in tax policy in order to increase funding for education and technological innovation through existing successful institutions.

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Peace and Economic Development in the Federally Administered Tribal Areas of Pakistan Nauman Afzal Afridi

ABSTRACT

The Federally Administered Tribal Area (FATA) of Pakistan is a volatile region with a unique history and culture. Low literacy rates, lack of economic activity, and religious and cultural barriers have kept this region underdeveloped for decades. Today, FATA is perceived as a breeding ground for terrorists which has led both the US and Pakistan to conduct military operations. Despite development efforts of the Pakistani government and international donor agencies like the United States Agency for International Development (USAID) and the United Nations (UN), the region remains underdeveloped. Additional measures need to be taken to improve economic conditions and eliminate existing terrorist threats. This study aims to evaluate the past efforts of the Pakistani government and other organizations to improve the situation in FATA. If the world hopes to achieve regional stability and truly combat terrorism, the development of FATA should be a priority. THE POLITICS OF SOUTH ASIA

apprehensive about India’s policies and worked to strengthen itself internally in case of future Pakistan was created in 1947 when the British attacks. In 1990, Pakistan decided to recognize left the Indian sub-continent, dividing it into two the Taliban government in Afghanistan which countries: India and Pakistan. During the same further complicated the region’s political situation. time period, the world was witnessing the Cold This antagonized India and the Northern Alliance War between the US and the Soviet Union. Both of Afghanistan, which had friendly relations with superpowers were looking to extend their sphere India. Although Pakistan and Afghanistan share of influence to other countries. Pakistan, as a a border of 1,500 miles and similar cultures, new state, was engulfed with various problems. these historical tensions are present today. A limited industrial base, weak government Along this stretch lies the Federally Administered structure, water and boundary disputes with India, Tribal Areas of Pakistan, which has become one and the massacre of Muslim refugees in India of the most dangerous and troubled places in the shaped Pakistan’s foreign policy during this time world. period. Pakistan chose to ally itself with the US and in return received foreign aid. Throughout FEDERALLY ADMINISTERED TRIBAL AREAS most of the 20th century, Pakistan and India OF PAKISTAN continued to clash, especially around Jammu and Kashmir territorial disputes. The first Indo- Since the terrorist attacks of September 11th Pakistani War began soon after independence in 2001, FATA of Pakistan has gained the attention 1947 and violent clashes continued until the end of the international community. As the War on Terror unfolded, FATA was perceived as of the century.1 a breeding ground for terrorists fleeing from Over the next six decades, Pakistan remained Afghanistan. This region is one of the most 2

isolated and underdeveloped regions in the world with high poverty rates, high illiteracy rates, and a serious lack of health facilities.

forces. The overall literacy rate is only 17 percent in FATA, with a 29 percent literacy rate among men and a mere 3 percent literacy rate among women.8 Due to the harsh physical features and Geo-Strategic Importance poor social indicators, the region has remained FATA is a semi-autonomous region of Pakistan, underdeveloped for decades. Despite its efforts, comparable to the size of Switzerland, and has the government of Pakistan has not been able a population of over three million.2 The region is to improve living conditions and FATA remains of significant geo-strategic importance because one of the poorest regions of the world with 70 of its proximity to Afghanistan. FATA consists percent of its population living on less than a 9 of seven tribal agencies: Bajaur, Mohmand, dollar a day. Khyber, Orakzai, Kurram, North Waziristan, and People and Culture South Waziristan. It also consists of six smaller regions known as the Frontier Regions (FRs): The people of FATA are mainly Muslim Pashtuns Bannu, Dera Ismail Khan, Kohat, Lakki Marwat, with smaller portions of the population belonging Peshawar, and Tank. The area is predominantly to non-Muslim denominations like Sikhs. Pashto mountainous with a number of passes through is the region’s most spoken language, although which invaders like the Turks, the Moghuls, various dialects are spoken in different agencies. the Greeks, and the Persians have historically Each agency is home to a number of tribes and crossed to get to the warm waters of the Indian sub-tribes. For instance, the Khyber agency Ocean.3 The most famous pass is the Khyber is home to the Afridi, Shinwari, Shilmani and Pass, which has a rich history and is presently Mulagori Orakzai tribes which can be further the main route for NATO forces for transporting broken down into sub-tribes.10 There are often supplies in and out of the region. It is also a trade age-old disputes and enmities between the subroute for landlocked Afghanistan. FATA shares tribes over issues like land or honor. Violence a 373-mile border with Afghanistan that lies over these disputes is common. between the province of Khyber Pakhtunkhwa of Pakistan and Afghanistan.4 The border of FATA The culture of FATA and the Pashtuns is based with Afghanistan is part of the 1,500 mile long on the Pakthunwali code, which revolves around Durand Line which stretches south until it meets the principles11 of hospitality, honor, sanctuary, the border of Iran. The Durand Line, named and revenge. Pashtuns are famous for their after Sir Mortimer Durand, is considered the hospitality and greet their guests very warmly. established boundary line between Pakistan and Pashtuns take great pride in their identity and Afghanistan.This line was drawn by the British look down upon people who belittle their culture. Their traditional code of revenge is very strong, colonial rulers between 1890 and 1893.5 and calls for an eye for an eye, which can often Economy of FATA lead sub-tribes to clash with one another. The economy of the area is dependent on pastoral and agricultural activities.6 Road networks are lacking in the region and FATA remains isolated from urban poles. Industry is almost nonexistent and few job opportunities exist for local people. Many educated people have settled outside of FATA in the major cities of Pakistan and seldom return to FATA, as there are few jobs or incentives to go back.7 The local population generally seeks employment in government departments or the para-military

Religion plays an important role in this area, and many people are strongly devoted to Islam. The society is traditionally paternalistic. Women are expected to cover their heads at all times and are required to wear a veil when outside. Women are often excluded from decision-making processes and are not allowed to work outside the home. FATA since the creation of Pakistan For centuries, FATA has been invaded by distinct groups. The arrival of the British in the Indian 3


sub-continent and their westward expansion towards Afghanistan had a major impact on the region. The British created the North West Frontier Province (NWFP) in 1901 (now Khyber Pakhtunkhwa) to manage their colonies in this region.12 For the adjoining region of FATA, they introduced a law known as the Frontier Crimes Regulation (FCR) to govern hostile tribes.13 This law combined traditional local customs and judicial powers to administer the region.14 After the creation of Pakistan in 1947, the law was kept, and with the exception of a few minor updates, remains unaltered. Each tribal agency is headed by a government official known as the Political Agent (PA) who is vested with the powers of the FCR. The PA wields enormous judicial, financial, and administrative power and the people have no right to appeal to the civil courts of the country.

When the Cold War ended, the US withdrew military and financial support from countries it had previously sought to influence. Pakistan, a frontline ally of the US, was put under sanctions by the introduction of the Pressler Amendment in 1990 because of its nuclear program.17 The sudden withdrawal of the US from the region had serious repercussions that would be felt a decade later. Poor economic conditions forced a large number of Afghan refugees to flow into FATA and other areas of Pakistan. The Afghan-Soviet War resulted in an influx of around four million Afghan refugees into Pakistan, which created economic and social problems in the country.18 The entire country was radicalized by the policies of dictator President General Zia-ul-Haq when he took power in 1977 by overthrowing the elected prime minister. He ruled the country for nearly a decade, introduced strict Islamic laws, and used religion to strengthen his autocratic rule in the When Pakistan was created, the country faced country. enormous difficulties and various economic and security concerns engulfed the new state. The General Zia’s rule had a significant effect on tribal people of FATA voted to join themselves to Pakistan’s society. The entire country witnessed the Pakistani government. The Government of the rise of militancy, drugs, and gun trafficking, Pakistan decided to respect the autonomy of the especially in FATA. This era gave rise to region by pulling out any troops present in FATA extremism in the region.19 Crime, drugs, and gunand continuing the British administrative system running continue unabated. The region remains of those territories.15 underdeveloped, literacy levels are low, and the people of FATA remain isolated from the rest of The Soviet invasion of Afghanistan 1979 Pakistan. It was not until the Soviet Union invaded Effects of 9/11 on FATA Afghanistan in 1979 that the international community took notice of the importance of Throughout the 1990s, FATA faced waves of FATA, and the US became concerned about the militancy and extremism, yet remained relatively expansion of the communist regime in this region. stable, despite weak government institutions.20 The US extended full support to the Afghans After the Soviets withdrew, civil war erupted and the tribal people from Pakistan, known as in Afghanistan and the Taliban took control in the Mujahideen, as they fought the Soviets. It 1996. They ruled most parts of the country and is estimated that between $6 billion USD and imposed draconian laws. Pakistan was forced to $8 billion USD was provided to the Mujahideen recognize the Taliban of Afghanistan to ensure to fight the holy war against the Soviets.16 The its western borders were not threatened. FATA Mujahideen were trained and provided with arms remained peaceful as most of the Taliban and for their incursions inside Afghanistan. It was in militants focused on weakening Afghanistan. this conflict that Osama bin Laden fought against Different factions of warlords fought each other the Soviets and was trained by the US. During for political control in Afghanistan. It was during this time, FATA had a weak government structure this time that the government of Pakistan realized and the legal institutions were further weakened reforms were needed in FATA, but it was unable to by the training of the Mujahideen. provide any support because tensions with India 4

had escalated, resulting in a need to prioritize the security of the India-Pakistan border.21

In 2011, the US tracked down Osama bin Laden and killed him in his house in the city of Abbottabad. Even after eliminating the world’s The terrorist attacks on September 11, 2001 most wanted terrorist, militancy and extremism led to the US invasion of Afghanistan. Due are still on the rise. The US planned to reduce to increased international pressure, Pakistan the numbers of troops in Afghanistan to 9,800 by reversed its recognition of the Taliban the end of 2014. They were then supposed to government in Afghanistan. The participants halve that number by the end of 2015, and finally of Operation Enduring Freedom started the reach a normal embassy presence by the end of invasion of Afghanistan in the mountains of Tora 2016.25 As of March 2015, 9,800 troops remained Bora in eastern Afghanistan adjacent to the and are scheduled to remain until at least the Kurram agency of FATA.22 Many members of end of the year.26 Despite these military victories, Al-Qaeda and the Taliban fled to the bordering it will take a long time to reduce extremism in the tribal areas of Pakistan and were given refuge by region. the local people of FATA, as is customary.23 The movement of the militants across the border had Peace in FATA serious repercussions, not only for the US and its allies, but also for Pakistan. Pakistan had to Peace is a prerequisite for any type of deploy a large number of troops in FATA to carry development activity. Since the War on Terror started, the government of Pakistan has tried to out operations against the militants. bring peace to FATA and the rest of the country. During this time period, suicide bombings by Al- Military operations and negotiations with militant Qaeda sponsored groups became increasingly organizations have failed on several occasions. prevalent throughout Pakistan. This brutal, new- The current situation of FATA cannot be attributed age warfare tactic placed fear in the hearts of to a single factor. Since the creation of Pakistan, innocents and claimed many lives. Violence in its weak institutions and lack of development the region continues to this day and has affected policies have resulted in low literacy levels, high poverty rates, and high crime rates. The all aspects of life in the region. lawlessness that was created by the Soviet The US was not satisfied with the efforts of invasion further weakened FATA’s governing Pakistan in fighting the militants in FATA. As the institutions. Achieving peace in FATA will be an US hunted down militants in Afghanistan, many enormous task due to the number of factors that fled to the adjoining area of Pakistan. In response, require attention. Peace in FATA is of the utmost the US initiated the first drone strikes in Pakistan importance; however, peace initiatives have to in 2004.24 The drone strikes increased during work in tandem with economic development in President Barack Obama’s administration. The the region. media coverage in the region is sparse and little can be ascertained about the actual casualties Strategies for Peace in the region. Achieving peace in FATA should be priority While the US might have been successful in for both Pakistan and the US for the following eliminating some terrorists by drone strikes, the reasons: FATA has porous borders with killing of civilians incited hatred within the region. Afghanistan; has witnessed much instability; and Some in the FATA tribal societies have retaliated has the potential to destabilize the region. If this by joining the militants and volunteering to area is neglected, similar to the post-Cold War carry out suicide attacks. The drone strikes era, it will have catastrophic consequences for have created much anti-American sentiment in both countries. The following suggestions could Pakistani society, and despite condemnation by be implemented to improve peace conditions in the Pakistani government, the US has continued the region: drone strikes. a. Eliminate Sources of Funding of Terrorist 5


ECONOMIC DEVELOPMENT OF FATA

Groups: Before any peace measures can be adopted, the government should put all its available resources in rooting out the sponsors of terrorist groups in FATA. Unless the sources of funding for terrorists are eliminated, it will be impossible to stop them. US and Pakistani intelligence agencies can play a vital role in identifying the sources of funding of these organizations. b.

c.

d.

e.

FATA is one of the most underdeveloped regions in the country with a poverty rate of over 70 percent.28 Poverty, combined with illiteracy and lack of basic human amenities, has further aggravated the conflict-hit region. Industry is almost nonexistent and very few livelihood opportunities are available to the local population. Many people ultimately get involved in the illegal Engage the Youth of FATA in Positive Activities: trade of smuggled goods, drugs, and weapons It is important to create an environment across the border of Afghanistan. Furthermore, where youth can succeed by having access the War on Terror has exacerbated people’s to education and job opportunities. Colleges struggles. Many of the local inhabitants have and universities, in settled areas of Pakistan, been displaced by the ongoing war between the have a quota for accepting students from militants and the security forces. These internally FATA. This quota should be increased. Better displaced persons have migrated to the settled job opportunities need to be created within parts of the country where they lead the life of the FATA region to decrease the temptation refugees – relying on aid from the government for unemployed youth to earn money from and various donor agencies. joining terrorist networks. Most of the tribal agencies thrive on government Continue Negotiations: Both the US and support and by means of illegal trade of Pakistan have tried to negotiate with terrorist smuggled goods. Each agency has its specialty groups but have had no success. In Pakistan, of smuggled goods. For instance, the Khyber negotiations have failed partly because of agency is known for smuggled electronic the lack of coordination between US and goods and daily consumption items.29 FATA Pakistani armed forces. In 2004, the Pakistani also possess raw resources such as minerals army reached an agreement with one of the and timber from various regions. A crude form militant’s leaders in South Waziristan agency, of marble is produced in Mohmand agency but he was killed one week later in a US drone and timber in North Waziristan Agency.30 The strike.27 Incidents like these have created militants extort money for safe passage of goods mistrust among the interested parties and and levy their own taxes or fines for un-Islamic acts committed by the local people. Kidnapping have discouraged further cooperation. for ransom was a common feature in the tribal End Drone Strikes: Drone strikes might have areas even prior to the rise of the militants. Now helped the US eliminate certain targets, but it is being used both by organized criminal gangs these strikes have great costs. Even a small and militants to fund their activities.31 Grinding number of civilian casualties by drone strikes poverty also encourages the youth to join the create hatred for the US. ranks of the militants, who pay them more than 32 Empower the Civil Administration: Since what they could otherwise earn. Long-term the beginning of the War on Terror, the civil economic development can be used to combat administration in FATA has been rendered all of these things. The more sustainable people helpless and the writ of the Political Agents are on their own, the less likely they are to rely has been weakened. The FCR law of FATA on doing business with militants. is often said to be outdated, but eliminating Development Efforts by the Government of it completely will not be prudent. It should be Pakistan amended to meet the specific needs of the region. Various governments in the past have tried to 6

develop FATA, but the results have not been encouraging. Lack of resources, corruption, and bad security hampered the development initiatives. There were minimal development efforts from 1947 until the Soviet invasion of Afghanistan in 1979. However, in the 1970s, the government of Prime Minister Zulfiqar Ali Bhutto introduced reforms. FATA was placed under the Federal Ministry of States and Frontier Regions and the FATA Development Corporation was established; quotas were introduced for the inhabitants of FATA in educational institutions and federal jobs; and colleges and roads were built. The 1980s and 1990s saw very few development efforts in the region and the only real achievement was the introduction of universal adult franchise for the people of FATA.33

Medical Corp (IMC). These international donor agencies rely on the government to execute the development projects because of the precarious situation in FATA. It is encouraging to see the government of Pakistan increasing the funding for the SDP of FATA. Various organizations are beginning to utilize software like geographic information systems (GIS) to monitor the program, yet the data received from the field is still not accurate due to poor legal institutions, inaccessibility of the region, and inefficiency of the local human resource.37 Despite difficulties, it is extremely important that development efforts be sustained. If left unattended like in the past, this region will again pose serious problems, not only for Pakistan, but for neighboring countries. US Economic Assistance to Pakistan

In 2002, the government created the FATA Secretariat and FATA Development Authority, which were solely responsible for affairs related to the region.34 As per the constitution of Pakistan, FATA is classified as a special area. An annual Development Plan is prepared for FATA and monetary allocations are made in different social sectors like education, health, communication, and many others.35

Since the creation of Pakistan and its early relationship with the US, aid has flowed in various forms. Economic aid to Pakistan peaked during the mid-1960s, a time when the Cold War and space race rivalry between the US and Soviet Union was at its peak. This large amount of aid coincided with the economic boom Pakistan experienced during the 1960s. Despite aid flowing in from the US, it is not clear how much of that aid was actually spent on the development of FATA. However, between the 1970s and 2000s, US economic and military assistance to Pakistan declined and various sanctions were imposed. Since the War on Terror started, US aid to Pakistan began to increase and it is estimated that the US provided $18 billion USD to $19 billion USD in aid – of which $14.2 billion USD was military related.38 This highlights that the US used more hard power and neglected to use soft power approach to improve the wartorn region. This aid was given to Pakistan for the sole purpose of supporting the US’s War on Terror campaign. The US relies more on USAID to provide funds for economic development versus directly providing economic assistance to the government agencies executing the projects.

Since 2006, spending for the development of FATA has increased; however, the effectiveness of the amount spent on development of FATA is uncertain. A survey was conducted in 2010 about various issues confronting the people of FATA and regarding the effectiveness of the FATA Secretariat and the FATA Development Authority. It revealed that only 21 percent of the people approved of the development efforts of the government.36 Due to the inaccessibility of the region and the poor security situation, it is extremely difficult to gauge the effectiveness of any development efforts. The government also initiated the Sustainable Development Plan 2006-2015 (SDP) for FATA which envisions a participatory approach in which the local population’s input is solicited to determine priority areas. The SDP is supported by various donor agencies like USAID, United Kingdom Department for International Development (DFID), and International

7

Presently, USAID, in coordination with the government of Pakistan, is carrying out various projects in FATA in areas such as livelihood generation, child protection and health


improvement, capacity building of government agencies, and infrastructure development.39 USAID’s economic assistance has increased since 2007, although military assistance to Pakistan is still much higher. A stronger soft power approach will greatly improve US popularity in the region.

family but as FATA is generally male-dominated this can be problematic within families. Second, it is extremely difficult to gather accurate data in this part of the country and effectiveness of any program cannot be monitored with accuracy. Finally, the amount of Rs 1000 ($10 USD) per month is also very low, especially because families are generally larger.

Economic Development Strategies for FATA

Conditional Cash Transfer Program for FATA

Considering the multiple factors involved in FATA’s current state, it is difficult to suggest a single policy measure to improve the security and economic condition of the region. It is extremely important the government of Pakistan and the international community continue their current development efforts and guarantee long-term funding. All development plans must focus on long-term effects rather than short-term achievements. It will be particularly difficult to win the hearts and minds of the youngest generation, who have been constant witnesses of poverty, violence, war, and destruction as they grow into adults. Furthermore, the vocational training of a few hundred people among a population of around four million inhabitants will not have any significant impact on society as a whole unless the number of people being trained is gradually increased every year.

Keeping in view the fragile situation in FATA, it is important to introduce a conditional cash transfer program solely for the people of FATA. This cash transfer program could have lasting effects on the impoverished, rural areas of FATA. The government of Pakistan and international donors should increase their funding for this specific program instead of increasing overall economic aid to Pakistan. The increased funding will help sustain the present development initiatives and also provide the conditional cash transfer to the people. The program does need to be tailored to suit FATA’s characteristics to ensure success. To increase education for the youth, the plan should stipulate that all families receiving cash must enroll all their children under the age of 17 in schools and they should have regular medical checkups. The World Food Program in Pakistan has successfully implemented a similar condition on another program.41 Arrangements should be made to measure the student enrollment and income levels of the population every year. The government should conduct annual surveys of schools and of random households to collect data. Moreover, the amount of cash should also be increased according to the number of children in the family. A mere $10 USD grant per month will not be sufficient because of the rising prices of goods of daily use.

This report aims to suggest an innovative path to economic development which will supplement the present efforts of government and international donor agencies. One such policy measure is the use of conditional cash transfers to the local population, while keeping in mind the norms and culture of FATA society. Although not specifically designated for FATA, the Pakistani government launched the Benazir Income Support program in 2008 which covers low-income people nationwide. The program does not put any conditions on cash transfer and pays an amount of Rs 1000 ($10 USD) per month to eligible families. The program is supported by the World Bank, the British Department for International Development, and USAID.40

Another important aspect of the program should be the proper identification of beneficiaries and the financial disbursement mechanism. The disbursement of cash will pose a problem This program has several shortcomings in its because most of FATA does not have an application to FATA. First, the program gives advanced banking system. Therefore, the office the money to the head female member of the of the Political Agent can be used to issue 8

minds of the people is important, and it cannot be achieved through continued violence.

money cards to eligible families. Monitoring of the disbursement process is of paramount importance, as the effectiveness of the program can only be verified if proper mechanisms are in place.

CONCLUSION

The rise of terrorism and militancy has negatively If planned and implemented properly, the affected developing countries like Pakistan. conditional cash transfer program will have far- Some level of success can be achieved by using reaching effects in FATA. This will be even more hard power to eliminate terrorist networks from successful if supported by strong educational Afghanistan and the FATA region of Pakistan. systems. The government should also ensure Perpetual peace, however, cannot be attained that besides providing schools, the quality of unless soft power is used and innovative education should also be made comparable economic development is supported in the with the rest of the country. The youth of FATA region. It is vital that all development efforts be deserve to be educated and compete both in sustained over a long period of time. It will be an arduous task to bring the region to par with national and international arenas. the rest of the country, but if neglected, FATA will continue to create serious security concerns. Recommendations for Economic Development: SOURCES a. Introduce Conditional Cash Transfer 1. BBC. India-Pakistan: Troubled Relations. 2002. Program: As highlighted above, the cash Retrieved on April 20, 2015. http://news.bbc. transfer program should be congruous with co.uk/hi/english/static/in_depth/south_asia/2002/ india_pakistan/timeline/default.stm the ground realities and the culture of FATA. 2. Rakisits, Claude. “Pakistan’s tribal areas: a critical no-man’s land,” in Webster Security Forum 2008: Identity and Conflict, Webster University Geneva, Geneva, Switzerland, pp. 127-138. 3. Ibid. 4. Federally Administered Tribal Areas http://www. globalsecurity.org/military/world/pakistan/fata. htm, Retrieved on 6/7/2013 5. Rakisits, Claude, “Pakistan’s tribal areas: a critical no-man’s land,” in Webster Security Forum 2008: Identity and Conflict, Webster University Geneva, Geneva, Switzerland, pp. 127-138. 6. Ibid. 7. Ibid. 8. Khan, Amina. “FATA: Voice of the Unheard – Path-dependency and Why History Matters.” Institute for Islamic Studies Islamabad.Web. 4 June 2013. <http://issi.org.pk/wp-content/ uploads/2014/06/1315805584_65172321.pdf>. 9. “Economic and Financial Woes of FATA.” FATA Research Centre RSS. Web. 1 July 2013. <http://frc.com.pk/commentaries/economic-andfinancial-woes-of-fata/>. 10. “FATA - Official Web Portal.” FATA - Official Web Portal. Web. 7 July 2013. <http://www.fata.gov. pk/Global.php?iId=32&fid=2&pId=28&mId=13>. 11. Khan, Amina. “FATA: Voice of the Unheard – Path-dependency and Why History Matters.” Institute for Islamic Studies Islamabad.. 4

b. Sustain Present Development Efforts: The present development efforts of the government and international donors should be sustainable. The US is an important stakeholder in the region as it is actively involved in the War on Terror in Afghanistan. The US should sustain its economic assistance and learn from lessons of the past. They should not repeat the policy of abandonment adopted after the Soviet defeat in Afghanistan. c. Improve Quality of Education: Building schools and infrastructure is the prerequisite for any development effort but it is not the end in itself. The quality of education imparted to the youth should also be improved to allow them to compete with rest of the country. d. Continue Peace Efforts: Peace in FATA is paramount to effective, sustainable development. Peace efforts and development initiatives should go in tandem. They will complement each other if a balance is maintained in fighting terrorists and spending on development. Winning the hearts and 9


June 2013. <http://issi.org.pk/wp-content/ uploads/2014/06/1315805584_65172321.pdf>. shorten source- second reference 12. Islamabad, Isambard. “Pakistan Renames North West Frontier Province to End ‘colonial Anachronism’” The Telegraph. Telegraph Media Group, 26 May 2008. Web. 16 Jul. 2013. <http:// www.telegraph.co.uk/news/worldnews/asia/ pakistan/2032986/Pakistan-renames-North-WestFrontier-Province-to-end-colonial-anachronism. html>. 13. Malik, Mohsin Abbas, Information Operations and FATA integration into the National Mainstream, Thesis Naval Postgraduate School, Monterey, California September 2012, Retrieved on 6/15/2013 14. Rakisits, Claude. Pakistan’s tribal areas: a critical no-man’s land, in Webster Security Forum 2008: Identity and Conflict, Webster University Geneva, Geneva, Switzerland, pp. 127-138. 15. Malik, Mohsin Abbas, Information Operations and FATA integration into the National Mainstream, Thesis Naval Postgraduate School, Monterey, California September 2012, Retrieved on 6/15/2013 16. Nawaz, Shuja. “FATA- A Most Dangerous Place.” CSIS. Center for Strategic and International Studies, 31 Jan. 2009. Web. 15 June 2013. <http://csis.org/files/media/csis/pubs/081218_ nawaz_fata_web.pdf>. 17. Ibid. 18. Dotani, Abdul Nasir. “The Impact of Afghan Crisis on Pakistan Society Since 1979 Till Date.” Government of Baluchistan. Web. 17 Apr. 2015. <http://global-studies.doshisha.ac.jp/attach/page/ GLOBAL_STUDIES-PAGE-EN-36/25398/file/ Dotani_Full_paper.pdf>. 19. Javaid, Umbreen, Partnership in War on Terror and Mounting Militant Extremism in Pakistan A Research Journal of South Asian Studies Vol. 26, No. 2, July-December 2011, Retrieved on 6/16/2013 http://pu.edu.pk/images/journal/csas/ PDF/V_26_No_2_1Dr.%20Umbreen%20Javaid. pdf 20. Orakzai Ali Mohmmad Jan et al., Situation in FATA: Causes, Consequences and the Way Forward, Institute of Policy Studies, Islamabad, June 2009 , Web. 16 June 2013. <http://www.ips. org.pk/global-issues-and-politics/1057-situationin-fata-causes-consequences-and-the-wayforward.html> 21. Rakisits, Claude. “Pakistan’s tribal areas: a critical no-man’s land”, in Webster Security Forum 2008: Identity and Conflict, Webster University Geneva, Geneva, Switzerland, pp. 127-138. Shorten second reference 22. Ibid. 23. Sayed Wiqar Ali Shah. Political Reforms in the

Federally Administered Tribal Areas of Pakistan (FATA): Will it End the Current Militancy? South Asia Institute Department of Political Science, Heidelberg University, Working Paper, January 2012, Web. 25 June 2013. <http://archiv.ub.uniheidelberg.de/volltextserver/13063/1/Heidelberg_ Papers_64_Ali_Shah.pdf> 24. Karl Kaltenthaler, William Miller, Christine Fair. The Drone War: Pakistani Public Attitudes toward American Drone Strikes in Pakistan, Paper prepared for presentation at the Annual Meetings of the Midwest Political Science Association Meetings, Chicago, IL. April 1317, 2012, Web. 9 July 2013. <www.uakron. edu/dotAsset/4823799c-34eb-4b4f-992eac4a2261e0c4.pdf‎> 25. Donati, Jessica. “Exclusive: U.S. to leave more troops in Afghanistan than first planned – sources.” Reuters, November 25, 2014. Retrieved on April 20, 2015. http://www.reuters. com/article/2014/11/25/us-afghanistan-usaidUSKCN0J91BG20141125 26. Shear, Michael, and Mark Mazetti. “U.S. to Delay Pullout of Troops from Afghanistan to Aid Strikes.” The New York Times, March 24, 2015. Retrieved on April 20, 2015. http://www.nytimes. com/2015/03/25/world/asia/ashraf-ghani-ofafghanistan-wants-us-troops-to-stay-longer.html 27. Mohmmad, Ali, and Jan Orazki. “Situation in FATA: Causes, Consequences and the Way Forward.” Situation in FATA: Causes, Consequences and the Way Forward. Institute of Policy Studies Islamabad. Web. 16 June 2013. <http://ips.org.pk/global-issues-and-politics/1057situation-in-fata-causes-consequences-and-theway-forward>. 28. Khan, Raza Economic and Financial Woes of FATA, FATA Research Centre, Web 1 July 2013, <http://frc.com.pk/commentaries/economic-andfinancial-woes-of-fata/> 29. Asif, Mian. “FATA: Tribal Economy in the Context of Ongoing Militancy.” (2009): 3. PAK Institute for Peace Studies. Web. 5 July 2013. <san-pips. com/download.php?f=24.pdf>. 30. Ibid. 31. Ibid. 32. Farooq, Mehreen, Hedieh Mirahmedi, and Waleed Ziad. “Developing FATA, A White Paper for USAID.” USAID White Papers (2009): 30. USAID. Web. 15 June 2013. <http://www. worde.org/wp-content/uploads/2011/12/ DevelopingFATA.pdf>. 33. Wirsing, Robert G, Ijaz Khan, and Pervaiz Iqbal Cheema. “Challenges Facing Pakistan’s Federally Administered Tribal Areas.” The National Bureau of Asian Research 19.3 (2008): 36. Web. 5 Aug. 2013. <http://www.nbr.org/ publications/nbranalysis/pdf/vol19no3.pdf>.

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34. Farooq, Mehreen, Hedieh Mirahmedi, and Waleed Ziad. “Developing FATA, A White Paper for USAID.” USAID White Papers (2009): 30. USAID. Web. 15 June 2013. <http://www. worde.org/wp-content/uploads/2011/12/ DevelopingFATA.pdf>. 35. Khan, Amina. “FATA: voice of the unheardpath dependency and history matters.” Web. 4 June 2013. <www.issi.org.pk/publicationfiles/1315805584_65172321.pdf‎ > 36. Shinwari, Naveed A, Understanding FATA: Attitude towards governance, religion and society in Pakistan’s Federally administered Tribal Areas, Community Appraisal and Motivation and Motivation Programme (CAMP) 2010, Web. 12 August 2013. <http://www.understandingfata.org/ files/Understanding-FATA-Vol-IV.pdf > 37. Farooq, Mehreen, Hedieh Mirahmedi, and Waleed Ziad. “Developing FATA, A White Paper for USAID.” USAID White Papers (2009): 30. USAID. Web. 15 June 2013. <http://www. worde.org/wp-content/uploads/2011/12/ DevelopingFATA.pdf>. 38. MacDonald, Elizabeth. “How much did the US give Pakistan?”. May 11, 2011 Fox News, retrieved on 7/1/2013 <http://www.foxbusiness. com/markets/2011/05/11/did-pakistan/> 39. Farooq, Mehreen, Hedieh Mirahmedi, and Waleed Ziad. “Developing FATA, A White Paper for USAID.” USAID White Papers (2009): 30. USAID. Web. 15 June 2013. <http://www. worde.org/wp-content/uploads/2011/12/ DevelopingFATA.pdf>. 40. “Benazir Income Support Program.” Government of Pakistan, official website. Retrieved on 8/20/2013 from http://www.bisp.gov.pk/ 41. Ebrahim, Zofeen. “Pakistan’s Fata area reports significant increase in school enrolment.” The Guardian. August 2012. Retrieved on 8/24/2013 from http://www.theguardian.com/globaldevelopment/2012/aug/09/pakistan-fata-areaincrease-school-enrolment

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Chile: Recommendations for Sustainable, Long-Term Growth Patricia Stubel

ABSTRACT

Chile is often cited as one of the best, easiest places to do business in the world, and is frequently the top-rated country for business in Latin America. There are several reasons for this, including a recent history of sound fiscal policy and a long history of strong democratic institutions. This paper first examines Chile’s economic history, its recent economic policies, and long-term concerns for growth. The second section examines the industrial and tax policies that make Chile’s business climate attractive to foreign investors. The paper concludes with policy recommendations for both Chilean industries and policymakers to foster long-term growth. These recommendations include minor adjustments in tax policy in order to increase funding for education and technological innovation through existing successful institutions. ECONOMIC HISTORY

workers and 33,000 railroad workers. Before the Great Depression, Chile had 1,355,000 active workers in the economy.2

In 1833, Chile’s constitution institutionalized political and economic control in the hands of the landowning elite for at least the next 60 years. Throughout the course of the 19th century, a new bourgeois elite developed around the new mining wealth of Chile. By the end of the 1800s, the landowners, mine owners, and businessmen formed an upper class which controlled both the economy and the government. These elite oversaw the expansion of commodity exports—particularly mining exports—that drove economic development from the mid-1800s to the Great Depression.1 In the latter half of the 19th century and the beginning of the 20th century, nitrate was Chile’s biggest export. These exports funded the building of infrastructure, supported the growth of industries such as railroads, and encouraged a large and growing urban sector. The exploitation of nitrate brought sustained economic growth, but also began the trend of “metropolization,” by which labor shifted from rural agriculture production to urban mining and services industries. By 1920, there were 57,000 nitrate workers, 80,000 other manufacturing

While the economy grew substantially throughout this period, the country’s wealth and political power were disproportionately concentrated in the upper class. Political and economic exclusion gave rise to a workers’ movement that would later affect, if not directly transform, the country’s political economy. In addition, inflation began to systemically appear as a defining feature of the economy. Borzutzky observes, Most of the analysts have traced the roots of inflation to a deliberate policy pursued by the Chilean landowners who cheapened the currency in order to settle mortgage debts in depreciated currency, while at the same time selling their products in England for sterling pounds. The inflationary process bore directly on both the very low living standards of the working class and the formation of a working-class movement, making the economic situation worse and anti-capitalism stronger.3

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Conditions for workers throughout this period continued to deteriorate. The urban population crowded into tiny rooms for housing, while

death and infant mortality rates rose to some of the worst in the world. Real wages continued to decline as workers were denied salary increases. In 1922, synthetic nitrates appeared on the world market. This drastically reduced the trading price of nitrate, Chile’s most important export, and threw the economy into a recession that left 47,000 nitrate workers without a job, as well as thousands of unemployed copper and coal miners.4 In response, workers staged strikes that often became violent, and more than 200,000 workers joined one of 204 unions by 1925.5 Finally, the end of WWI heralded a recession that destabilized the economy profoundly, exacerbating the inequality, poor living conditions and social, and economic systems based on the dominance of the upper class.

economy for decades to come. In order to accommodate the needs of the previously disenfranchised classes, the state expanded its socioeconomic programs by expanding the money supply, putting an upward pressure on inflation. In addition, each administration provided only partial responses to inflation; no policy addressed its root causes.8 Structural changes, particularly to productivity in the agricultural sector, never occurred; the next 50 years saw dramatic urbanization, reliance on copper and very slow average GDP growth. This, combined with inflation, meant a continued increase in inequality.9 Today, Chile is still one of the most unequal countries in the world in terms of wealth disparity.10 The Arturo Alessandri Palma administration, charged with implementing the 1925 Constitution, had the misfortune of beginning these policy changes in the midst of the worst economic depression in modernity. The fall in nitrate prices dramatically increased Chilean unemployment. Copper became Chile’s dominant export, and as policymakers began to contemplate Chile’s trade policies, the Great Depression set in. In an attempt to shield the Chilean economy from the global economic downturn, protectionism flared.

The end of Chile’s control of the nitrate market proved to be the final blow to the status quo. In September of 1924, a military intervention resulted in overhauled social and economic legislation and subsequent constitutional reform in 1925. These reforms, combined with international events and the sudden inclusion of lower classes in the political system, altered the economic model for the next 50 years.6 Constitutional changes in 1925 led to the establishment of a new multiparty political system, the expansion of the right to vote, and the expansion of the economic functions of the state. This expansion, in turn, led to a clientelistic system characterized by the use of state-provided functions by members of Congress. From 1925-1973, the state generally implemented an import substitution model, including protectionist policies and state acquisition of key industries. This time period was also marked by political deadlock through which the landowning right maintained its power, effectively blocking many structural changes to the economic system that may have enabled greater economic success.7 The major economic changes invoked by the 1925 Constitution marked the acceleration and deepening of the inflationary process which would continue to be a problem for Chile’s

To make matters worse, the United States’ Smoot-Hawley Act of 1931 set off a trade war, the effects of which would not be resolved until after World War II.11 The combined effects of the disappearance of Chile’s export markets and the need to create jobs led to the implementation of an import-substitution model based on high tariffs, government investments in the industrial sector, and an almost exclusive reliance on its exports of copper as the source of foreign trade. Additionally, this development model included taxes to support a large and growing public sector as well as direct state ownership of industries deemed important to the government.12 Indeed, the scope of government participation in the economy was such that, By the late 1960s the state had acquired a

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The results of Frei’s economic policies were mixed, in part due to Congress’s resistance to implementing them. The inability to move forward with the substantial changes in policy due to political deadlock triggered a massive expansion of the state’s role in the economy as well as an influx of participants into the political system. This influx and the incomplete or inadequate implementation of Frei’s program augmented the existing polarization of political forces and exposed the deep differences among groups in Chilean society.16

preponderant economic role, owning either totally or partially some of the most important sectors of the economy such as copper, steel, petrochemicals, telecommunications, petroleum, and electricity. … The state, through the Central Bank, controlled imports and exports, … controlled over half of the credit available to the private sector, … [set] prices for most consumer goods, … [and] controlled over 40% of total GDP and … 70% of total Gross Domestic Investment.13

While the 1925 Constitution allowed for more groups to be involved politically, it also encouraged clientelistic ties that inevitably destabilized the political system and increased public sector size and spending levels. Despite greater political participation, in practice there was still a gross underrepresentation of the working class population until 1958 due to the nature of the electoral system and the way in which ballots were distributed. This effectively maintained the power of the landowning right, much of which was reflected in Congressional representation. The majority of the country’s preferences were represented by their choice in president. However, the power to initiate many of the structural reforms required to address inflation, income distribution, productivity, and socioeconomic progress was held by Congress. Thus, despite majority consensus for change, impactful policies to confront these issues were stalled indefinitely.14

Political deadlock would follow the left’s next candidate and Frei’s successor: Salvador Allende. Allende continued Frei’s attempts to reduce inequality and pursue significant socioeconomic changes, as supported by the majority of Chileans. His socialist program included nationalizing the copper industry as well as banks, large companies and industries, and utilities, redistribution of income meant to engage demand-led economic growth, and an increased emphasis on protectionism.17 As Allende tried to push for economic sectors to be nationalized, or included in the Social Property Area, followers from the left forcefully took over companies and land, and extremist groups from both the right and the left reacted violently. These takeovers eroded Allende’s support at a time when Congress was already bitterly divided. Often, these businesses were given to political supporters to operate, regardless of technical ability or background, leading to gross financial mismanagement.18

By the 1960s, the socioeconomic situation had come to a critical point. The import substitution model had proven to be ineffective at sustaining growth, inequality and inflation had increased substantially in the three to four decades prior, and dependence on internationally-owned copper monopolies continued to exacerbate the country’s economic state. In 1964, Eduardo Frei won a landslide victory in the presidential election. Frei intended to improve Chile’s affairs by implementing an ambitious program that emphasized communitarian state programs. Specifically, he introduced policies meant to increase agricultural productivity and savings rates, attract foreign investment, and tackle inflation through a gradual stabilization policy.15

In reaction to President Allende’s decision to nationalize the copper industry without compensating the two large American companies that controlled it, U.S. President Richard Nixon initiated a covert campaign to destabilize the Chilean government. The Nixon administration supplied over $6 million for covert actions, effectively strengthening Allende’s opposition, and weakening the ability of the administration to enact economic change. Overall, President Allende failed to understand the implications of Cold War policy in both 14

the U.S. and U.S.S.R.; these policies were responsible for many regime changes in Latin America, and Chile was no exception. This, combined with his inability to initiate economic growth and control inflation, as well as his failure to unite disparate groups including the political elite, led to a coup in 1973.19

thereby creating more wealth and reducing poverty.22 The monetarist economic policies known as shock therapy reduced the role of the state in the economy dramatically, opened the country to foreign competition and capital flows, reduced fiscal spending, made the exchange rate competitive and export-oriented, and fostered a private sector capable of fully using Chile’s comparative advantages. In order to make firms more competitive, labor laws were liberalized, allowing massive layoffs and wage reductions.23

In September of 1973, the Chilean presidential palace, La Moneda, was bombed in a coup led by the military, marking the beginning of the Pinochet regime.20 Apart from its economic policies, it should be noted that the first three years of Augusto Pinochet’s regime were the most brutal:

The initial monetarist policies resulted in the largest depression Chile had seen since the 1930s, and the largest national debt in Chilean history, a sum totaling $13.6 billion by the end of 1982. Wages continued to be cut and the brunt of the damage done by the policies was borne by the lower and middle classes. The financial system collapsed in 1984 after international lending slowed to a minimum.24

The destruction of the previous system was the central mission. It is a matter of public knowledge that in order to achieve that destruction the government carried out political assassinations, torture, and imprisonment of political, labor and student leaders, and of militants of the Socialist and Communist parties and the leftist movements. From an institutional perspective, the destruction of the old political system involved the ‘suspension’ of the activities of the Congress, political parties, and unions. In the new regime, power was concentrated in the Junta de Gobierno formed by the Commandersin-Chief of the Army, Navy, and Air Force, and the General Director of the National Police, and repression served as the basic channel of communication between the authoritarian regime and a subjugated society.21

In 1985, Hernán Büchi became the Minister of Finance and modified the economic model to alleviate the economic crisis. His policies entailed high exchange rates, the encouragement of non-traditional exports through protectionist policies, and lower taxes. Büchi was particularly successful at reducing the debt burden and privatizing state owned companies with the use of debt/equity swaps, in which discounted debt notes in Chilean-owned companies were sold internationally. This policy also reinserted both foreign entrepreneurs and the military into the economy.25

A group of Chilean neo-liberal economists known as the Chicago Boys were enlisted to provide the new regime a well-defined economic program, which eventually informed the country’s economic policy. The Chicago Boys supported the immediate implementation of a full array of monetarist policies in order to shift the country into a full capitalistic society. Subsequently, the 1980 Constitution not only legitimized Pinochet’s rule, but institutionalized the consolidation of capitalism in Chile by slashing the socioeconomic functions of the state, replacing Keynesian policies with monetarist ones, and putting in place an export-oriented economic model. The belief of the Chicago Boys was that this market-based approach would correct economic inefficiencies, 15

Economic performance during the Pinochet regime was mixed. The income inequality gap continued to widen, and the shock therapy did not prove a good medicine. Still, the 1980 Constitution continues to affect the Chilean economy, in terms of both the structure of the economic model and its participants. Moreover, the 17 years of Pinochet’s repression and enforced capitalism had their effect on the country and its narrative, creating a more market-oriented and individualistic society.


In 1990, Augusto Pinochet ceded power to a democratically elected government.26

as well; however, her administration largely ignored regressive Chilean tax policies. Indeed, no real moves have been made by any recent administration to reform the tax system. In general, moves towards a more equitable society have been tempered by the repeated decision to place priority on maintaining the market economy.32

ECONOMIC POLICIES: 1990 TO PRESENT The 1990 return to democracy saw a continuance of the previously existing neoliberal economic model that we see to this day. Presidents Patricio Aylwin and Eduardo Frei followed General Pinochet, and used money generated from high GDP growth and small tax increases to increase social spending and reduce poverty. While poverty was reduced by half and extreme poverty by more than half,27 income inequality remains very high in Chile, at 15th worst in the world.28

In 2010, Sebastián Piñera became the first president from the political right to be elected since 1958. His party did not have a Congressional majority, and thus, large structural policy reform was implausible under his administration. From the Alianza, or centerright coalition, Piñera sought to make marginal incremental changes to promote a more equitable society. Specifically, he increased taxes and implemented an Ethical Family Income program for families barely above the poverty line. The social welfare emphasis of his administration made him less popular among conservatives, even as he faced disruptive protests from the left regarding university education and environmental issues. The Piñera administration’s popularity rating was 34% as of April 2013.33

Due to the Asian crisis of the late 1990s, Chile saw its rapid growth slow. Recovery began again in 2003, and the economy was prosperous until the impact of the 2008 global crisis. Inflation remained low (around 3% from 2000 to 2007), and from 1990 to 2007 unemployment retained a relatively high rate, averaging 8.1% even as GDP grew an average 5.5% per year over the same time period.29 From 2000 to 2005 the Ricardo Lagos administration, followed by the Michelle Bachelet administration, were in power. Both continued the process of globalization and deepened the market model, even as both recognized and publicly spoke against the continued inequality in Chile. A series of free trade agreements (FTAs) furthered Chile’s trend towards globalization; by May of 2013 Chile had signed over 60 FTAs,30 granting it access to a group of countries which constitute 81% of global GDP. While both administrations sought to reconcile the inequality gap further advanced by globalization, President Lagos’s attempt did not include major legislation to tackle it. Still, it should be noted that in the five years he was president, Chile once again halved the number of people living in poverty, lowering it to 13% of the population.31 Bachelet furthered her aims in reducing inequality by reforming the pension system and increasing funding to the health system. Tax policy reform could have improved inequality,

Much political attention centered on Michelle Bachelet’s return to office after the November 2013 elections. She proposed major reforms to higher education, appealing to the student protestors. To pay for this expense, she proposed increasing corporate taxes and reducing corporate tax benefits. Her platform included reducing pro-market economy policies in favor of more equitable socioeconomic policies, including educational support starting at pre-school and policies to redistribute wealth.34 The Concertación before her had not changed its economic policies since taking control after Pinochet left office.

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The Concertación’s fiscal policies, in place since 1990, favored a strong, independent Central Bank, low levels of inflation, and conservative fiscal spending. These policies came under attack in the 2000s as Chile switched from a debtor to a creditor country. Instead of expanding public spending for things

like education and health, most of the surplus went to the equivalent of an offshore rainy day fund. These policies were vindicated as the subprime mortgage crisis unfolded in 2009, and Bachelet was able to introduce a $4 billion stimulus package, including special economic measures for low-income families.35

concerns, extreme inequality is detrimental to long-term macroeconomic growth.38 In order to maintain its long-term economic health, Chile must take steps to reduce the inequality gap. Poverty and Near Poverty Related to gross inequality is poverty. The lower and middle classes bore the cost of change at every major political transition throughout Chile’s history. The Pinochet regime in particular forced the cost of implementing capitalism onto the lower classes, and in 1987 a staggering 45% of the population lived below the poverty line. Concertación administrations reduced poverty to 13.7% by 2005,39 although it rebounded to 15.1% in 2013.40 Analysts have pointed out that instead of bringing the masses out of poverty, these administrations merely brought these citizens just over the poverty line, and that many are in danger of falling back into poverty on a daily basis.41

Currently, a full third of Chile’s GDP growth is attributable to exports, 75% of which are commodities. Even during the global recession, Chile’s growth was strong, averaging 5% per year from 2003 to 2012. In 2012, foreign direct investment (FDI) reached $28.2 billion, and at $18,200 Chile’s GDP per capita is the highest in South America. Chile is fiscally sound; public debt is only 11.9% of GDP, one of the lowest rates in the world, and in 2012 it ran a budget surplus of $1.5 billion, about 0.5% of GDP.36 The market-led economy has certainly been successful in many ways. Prudent fiscal policy over the last two decades has generated great benefits, turning Chile from a debtor to a creditor country and allowing it to smooth global financial shocks with the creation and maintenance of a sovereign wealth fund. Unfortunately, the economic cost of the implementation of these policies was a dramatic increase in poverty and inequality, and since 1990, administrations have sought to rectify both of these issues with some success. Despite clear macroeconomic health, the political and social instability wrought by inequality presents long-term economic problems for Chile, and can only be rectified through prudent investments in education, research, and technology to take advantage of deepening global economic ties and technological advancement.

Additionally, a breakdown of labor force composition reinforces the financial insecurity of many Chileans. Only 42% of the labor force is employed under a traditional contract, which is the only legally enforced type of contract that provides employment security. A full 34% of labor participants are employed either without a written contract or under atypical contracts. Those employed without a contract have the lowest income, are subject to extreme uncertainty regarding how long they will be employed, and have very little or no legal recourse against employers. These labor conditions contribute directly to the insecurity of families living at or under the poverty line.42 To alleviate this problem, a discussion of an ethical wage has been introduced. The Catholic Archbishop Goic made a statement regarding the need for an ethical wage, which would have increased minimum wage by 40% at the time. Such explicit intervention by the Catholic Church was ultimately extremely influential in Piñera’s ability to pass the Ethical Family Income program through Congress.43

LONG TERM AREAS OF CONCERN Inequality Chile ranks 15th worst in the world in terms of inequality after government transfers. Low social mobility has precipitated popular student demonstrations, and general disillusionment with the political class.37 Such political disillusionment and instability can quickly lead to capital flight and the loss of FDI. In addition to political

17

Much like inequality, poverty is not solely a humanitarian concern; it discourages


international investment, and imposes social and economic costs on the rest of society.44 Additionally, these levels of poverty indicate severe underinvestment in human capital. As Chile’s economy develops and integrates further into the world economy, Chile will need to increase its human capital in order to continue to compete at its current level.45

direct investment it receives.51 In order to diversify from natural resource exports, Chile has attempted to use several agencies under Chile’s economic development corporation CORFO (Corporación de Fomento de la Producción) to encourage innovation and increase technological infrastructure in existing industries. Thus, one of the core ways in which Chile promotes industries and exports is through CORFO and CONICYT (Consejo Nacional de Investigación en Ciencia y Tecnología), another agency promoting industrial development. In addition, institutions including ProChile and ministries like the Ministry of Agriculture have a hand in shaping industrial policy. The following figure from the InterAmerican Development Bank describes the various ways in which Chile encourages industrial growth, particularly in terms of boosting innovation (see Figure 1).52

Copper Dependence In the 1800s, Chile depended primarily on nitrate exports to fuel its economy. In 1922, a recession initiated by a nitrate price shock sent the economy reeling. This was later compounded by a political coup and then a global depression. For the next 50 years, Chile devoted its economic activity to a protectionist import substitution model, which did not allow for significant growth. Nor did it reduce Chile’s reliance on primary exports, as copper quickly replaced nitrate as the dominant export.46

CORFO (Corporación de Fomento de la Producción)

Since the early 1990s, administrations have pursued countercyclical policies to smooth against price shocks in copper, but have not necessarily addressed Chile’s dependence on primary exports. In 2012, copper constituted 55% of Chile’s exports.47 Robert Solow— Nobel Prize winning economist whose work focuses on development, technology, and long-term growth—stated concern over Chile’s dependence on copper. Specifically, he implored Chilean policy makers and employers to move towards value-added exports and increased investment in human capital. This is the only way to allow for long-run sustainability and growth of the Chilean economy.48

CORFO was established in 1939 as a development agency and has evolved over time. It was used by the military regime in the 1980s to relieve the effects of perceived market failures. The caveat to creating this agency was that it would never choose industries that would benefit from funding, as that was perceived as not allowing the market to decide which industries would succeed. Rather, it took a more market-oriented or horizontal approach, with the exception of forestry. This approach is by and large maintained by the current structure of CORFO’s programs, although recently moves have been made to fund industries of greater comparative advantage.53

Chilean Industrial Policy and Business Climate The World Bank cites Chile as the top country in the region with which to do business.49 Much of this has to do with its stable economy and rules-based business environment,50 owing to the fiscal and countercyclical policies outlined previously. Chile has made a concerted effort in its industrial policy to promote foreign business in the country, which is reflected in its World Bank rating as well as the amount of foreign

In its current form, CORFO is a second-tier institution with 4 competencies: a. the provision of subsidized services to Small and Medium Enterprises or SMEs (Gerencia de Fomento); b. investment promotion…; c. a variety of innovation subsidies…; and 18

d. several financial programs that basically provide long-term capital to SMEs (Gerencia de Intermediación Financiera, GIF).54

ICT, such as call centers and business process offshoring; production and diffusion of multimedia contents; biotechnology and pharmaceutical products; and production of new materials.”56

The following is a brief overview of programs that CORFO funds or manages:

• Innova Chile: This branch of CORFO has six programs aimed at fostering innovation. It is run by a special committee and independent board consisting of industry leaders and members of CORFO. Its programs provide seed capital to start-ups, tax incentives for R&D, connections to angel investors, technical assistance to firms looking to implement new technologies, and support via business incubators. In addition, it has a business innovation program that will be discussed in greater detail below.57

• Gerencia de Fomento allocates money to regional offices, which is then distributed to business associations in an effort to assist small to medium-sized enterprises. It particularly assists small firms looking to compete with larger ones by providing technical services; it does this on a matching grant basis, thereby subsidizing SMEs’ access to these services. In 2007, Fomento’s budget was $46 million.55 • Investment Promotion: Since 2000, CORFO has funded a program to attract foreign direct investment (FDI) in high technology. This includes subsidizing and providing services to the following industries: “software production; production of hardware; services using intensively 19

• Gerencia de Intermediación Financianciera (GIF) is CORFO’s development bank, which provides long-term loans to SMEs. It also has two lines of credit that allocate loans to undergraduate and graduate students. The total budget of GIF was $1.1 billion in 2007,


which is substantially larger than that of any of CORFO’s other programs, but constitutes only 1.1% of Chile’s total financial system.58

dependence on primary product exports has not significantly decreased. This is due in part to the relatively low level of funding to the programs above. In particular, increasing funding to CORFO’s High Technology FDI program, Innova Chile’s operations, and Fundación Chile would prompt innovation and export diversification at a higher level.62

Other While CORFO is the most prominent organization determining industrial policy in Chile, there are several other programs aimed at businesses:

One of Chile’s greatest industrial strengths is how easy it is to start a business there. The World Bank and International Finance Corporation cite protection of investors and tax policy as advantages in attracting new business. Two other areas in which the country performs well are dealing with construction permits and resolving insolvency.

• Fundación Chile: This is a private non-profit established in 1976 that acts in many ways like a public-private partnership. Fundación Chile acts like a venture capitalist firm, and unlike most of CORFO’s programs, concentrates its funding in sectors in which Chile has a comparative advantage. For example, it is responsible for the success of Chile’s salmon industry. In large part, Fundación Chile focuses on enabling technology transfer by adapting existing technologies to industries in which Chile has comparative advantages.59

Tax Policy By and large, the Chilean tax policy is one of the most preferential in the world. There is a 17% corporate tax rate, although this has been temporarily raised to 20% in the face of natural and man-made disasters in 2011 and 2012. Tax enforcement does not discriminate between local and international parties, which makes Chile quite desirable to foreign firms as a location. There is an additional 19% Value Added Tax on real estate, services, and imports. However, this is exempted for exports, and any locally acquired capital is treated preferentially. In addition, the tax system has several perks, such as deductions for interest, either paid or accrued; losses, which can be carried forward indefinitely; royalties; and wages for employees.63

• Servicio Nacional de Capacitación y Empleo (SENCE): SENCE was established during Pinochet’s regime. It certifies firms that engage in training, and provides tax deductions to firms that engage the services of training firms in order to encourage human capital development.60 • Servicio de Cooperación Técnica (SERCOTEC): SERCOTEC provides loans and technical assistance for Small and Medium sized Enterprises (SMEs), as well as some services for Micro and Small Enterprises (MSEs).61

There are also significant legal and fiscal exceptions for businesses, particularly for mining companies.64 As a point of comparison, the figure above summarizes Chile’s effective tax rate on the mining industry, and compares it to other countries (see Figure 2).65

Overall, it is clear that Chile’s industrial policy supports SMEs and heavily favors innovation, in terms of both incentivizing increased technological capability in traditional industries as well as attempting to build capacity in new ones. In particular, Innova Chile and Fundación Chile have replaced a lackluster venture capitalist community and a lack of significant initial public offerings. It should be noted that many of these policies and programs have been in place since the early 1990s, and the 20

While much of the requisite infrastructure is in place to effectively capture taxes,66 tax evasion is still of concern in Chile. The OECD has recommended that Chile increase its mining taxes to fight inequality, citing that this will not reduce mining FDI. Indeed, any reduction

in investment will most likely correspond to reduction in global demand, particularly as China’s economy growth slows.67 It is important to note, however, that previous increases to mining taxes have not fared well, due to congressional opposition.

English (an offshoot of its High Technology FDI program) should be exponentially increased from its level of 2,000 students in 2009.70 Given Chile’s advantage of being in the same time zone as the U.S. east coast, increased capacity in business English would increase service exports.

POLICY RECOMMENDATIONS FOR EDUCATION AND HUMAN CAPITAL

In addition, increasing the operations of Fundación Chile, which utilizes Chilean universities extensively, would not only provide the needed functions of venture capital investment and technology dissemination, but would also increase the demand for university resources and students. Much like the effects of brain drain, this perceived demand for an educated workforce and higher expected value of education would increase the amount of students willing to continue their education, on account of a higher expected payoff.71

In addition to increasing the technological capacities of Chilean industry, a concurrent push needs to be made in funding education. Chile is regularly cited as lacking in human capital,68 and has recently slipped in world business rankings due to its low expenditure on education.69 In order for Chile to be able to move exports up the value chain, it must invest in education at every level. This would further enable foreign companies to set up subsidiaries in Chile, bringing capital, employment opportunities, and technological growth. CORFO’s program training students in business

POLICY RECOMMENDATIONS FOR ENERGY AND ENVIRONMENTAL POLICY 21


Energy is becoming an area of growing concern. It is, by and large, imported into Chile, with the exception of hydroelectric energy production. Chile has long-term environmental concerns regarding its water resources, many of which are currently being captured by hydroelectric plants. The power provided by hydroelectricity is necessary to maintain high sustained growth rates, but has raised environmental concerns.72 Fundación Chile funds a number of alternative energy firms, including one which is uses wood pellets for bioenergy and another which is developing new solar panel technology. Alternative energy research, particularly if it utilizes a resource Chile considers a comparative advantage, would help solve fulfill the demand for energy while protecting the health of local water resources.

In order to pay for the expansion of Fundación Chile, the tax policy must change. First, the government must establish protocols to combat tax evasion. Second, taxes on mining companies should increase. With a 2-3% increase in the effective tax rate, particularly in the royalties, taxes will still be well within the preferred zone for mining companies, but could significantly increase funding for Fundación Chile, as well as any long-term educational reform presented by President Bachelet. CONCLUSION Chile’s long-term growth requires serious investments in human capital and technology. To finance this, mining taxes should be minimally increased to fund Fundación Chile and education. Additionally, environmental reforms should be carried out in order to decrease uncertainty for foreign investors. Without taking steps in this direction, Chile will be dependent on natural resources, particularly copper, and ultimately will be unable to sustain its growth in the future.

In addition, uncertainty surrounding environmental and energy policy, and the activism of courts, which have largely backed environmental advocates, have slowed investments into the country. The Globe and Mail reports that local communities are

SOURCES

increasingly turning to the courts, which are seen as one of the more trustworthy institutions. The Federation of Chilean Industry recently reported that $55-billion worth of infrastructure, energy and mining projects that have received environmental approvals are tied up in court cases.

Implementing clear-cut environmental reforms would appease the population as well as enable greater investment by decreasing uncertainty. THE ROLE OF FUNDACIÓN CHILE AND ITS EXPANSION Fundación Chile’s model generally finances technological innovation in sectors of the economy in which Chile has a comparative advantage. Increasing the ability of Fundación Chile to fund more projects and longerterm projects would have a real impact on establishing higher-value exports in areas like forestry and mining. This would effectively capitalize on current strengths while diversifying exports and modernizing the economy.

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1. Silvia Borzutzky. Chapter 1. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 2. Ibid. 3. Ibid. 4. Ibid. 5. Ibid. 6. Ibid. 7. Ibid. 8. Silvia Borzutzky. Chapter 2. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 9. Silvia Borzutzky. Chapter 1. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 10. “Gini Index,” The World Bank. Accessed August 27, 2013, http://data.worldbank.org/indicator/ SI.POV.GINI. 11. “Protectionism: The Battle of Smoot-Hawley,” The Economist. (2008, December 18). Retrieved November 9, 2013, http://www.economist.com/ node/1279859. 12. Silvia Borzutzky. Chapter 2. Vital Connections: Politics, Social Security, and Inequality in Chile.

(Notre Dame, Ind.: University of Notre Dame Press, 2002). 13. Ibid., 28. 14. Ibid., 23. 15. Silvia Borzutzky. Chapter 4. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 16. Ibid. 17. Silvia Borzutzky. Chapter 6. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 18. Ibid. 19. Ibid. 20. Ibid. 21. Ibid., 160. 22. Silvia Borzutzky. Chapter 7. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 23. Ibid. 24. Ibid. 25. Ibid., 188-191. 26. Ibid., 196-202. 27. Ibid., 251-252. 28. “Chile,” The World Factbook. Central Intelligence Agency. Accessed June 7, 2013, https://www.cia. gov/library/publications/the-world-factbook/geos/ ci.html. 29. Silvia Borzutzky and G. B. Weeks. “Socioeconomic Policies: Taming the Market in a Globalized Economy.” The Bachelet Government: Conflict and Consensus in Post-Pinochet Chile. (Gainesville: University Press of Florida, 2010), 109. 30. P.J. Meyer. “Chile: Political and Economic Conditions and U.S. Relations,” Congressional Research Service. Accessed June 12, 2013, http://www.fas.org/sgp/crs/row/R40126.pdf. 31. Silvia Borzutzky. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002), 107-118. 32. Ibid., 114-148. 33. P.J. Meyer. “Chile: Political and Economic Conditions and U.S. Relations,” Congressional Research Service. Accessed June 12, 2013, http://www.fas.org/sgp/crs/row/R40126.pdf. 34. “Chile’s Presidential Election: Cruising Back to La Moneda,” The Economist. Accessed November 9, 2013, http://www.economist.com/news/ americas/21589430-more-left-wing-michellebachelet-set-win-tide-social -discontent-cruisingback. 35. Silvia Borzutzky. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press,

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2002), 116-121, 143-145. 36. “Distribution of Family Income – Gini Index,” The World Factbook. Central Intelligence Agency. Accessed December 12, 2013, https://www. cia.gov/library/publications/the-world-factbook/ rankorder/2172rank.html. 37. Ibid. 38. A. Berg and J. Ostry. “Equality and Efficiency,” Finance & Development. International Monetary Fund. (2011, September 2). Accessed December 3, 2013, http://www.imf.org/external/pubs/ft/ fandd/2011/09/Berg.html. 39. Silvia Borzutzky and G. B. Weeks. “Socioeconomic Policies: Taming the Market in a Globalized Economy.” The Bachelet Government: Conflict and Consensus in Post-Pinochet Chile. (Gainesville: University Press of Florida, 2010), 139. 40. “Chile Population Below Poverty Line,” Index Mundi. Accessed December 11, 2013, http:// www.indexmundi.com/chile/population. 41. Silvia Borzutzky and L. H. Oppenheim. “Chilean Economic Policy under the Concertación: The Triumph of the Market?” After Pinochet: the Chilean Road to Democracy and the Market. (Gainesville, FL: University Press of Florida, 2006), 93-117. 42. Silvia Borzutzky. Chapter 6. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 43. Ibid. 44. “Poverty in America.” Government Accountability Office. Accessed October 13, 2013, http://www. gao.gov/new.items/d07344.pdf. 45. Silvia Borzutzky and G. B. Weeks. “Unresolved Conflict Within the Consensus: Bachelet’s Inheritance of Labor and Employment Issues.” The Bachelet Government: Conflict and Consensus in Post-Pinochet Chile. (Gainesville: University Press of Florida, 2010), 136-157. 46. Silvia Borzutzky. Chapter 2. Vital Connections: Politics, Social Security, and Inequality in Chile. (Notre Dame, Ind.: University of Notre Dame Press, 2002). 47. P.J. Meyer. “Chile: Political and Economic Conditions and U.S. Relations,” Congressional Research Service. Accessed June 12, 2013, http://www.fas.org/sgp/crs/row/R40126.pdf. 48. Kirsten Sehnbruch. “A Record Number of Conflicts? Michelle Bachelet’s Inheritance of Unresolved Employment Issues,” Center for Latin American Studies, University of California, Berkley. http://clas.berkeley.edu/sites/default/ files/shared/docs/papers/Sehnbruch4WebBook. pdf. 49. “Doing Business in Chile,” World Bank Group. Accessed September 8, 2013, http://www.


doingbusiness.org/data/exploreeconomies/chile. 50. M. R. Agosin, C. Larraín and N. Grau. “Industrial Policy in Chile,” IDB Working Paper Series. Accessed August 9, 2013, http://idbdocs.iadb.org/ wsdocs/getdocument.aspx?docnum=35472108. 51. “Chile,” Economic Commission for Latin America and the Caribbean. Accessed October 29, 2013, http://www.eclac.org/publicaciones/xml/3/48593/ Chile_ing.pdf. 52. M. R. Agosin, C. Larraín and N. Grau. “Industrial Policy in Chile,” IDB Working Paper Series. Accessed August 9, 2013, http://idbdocs.iadb.org/ wsdocs/getdocument.aspx?docnum=35472108. 53. Ibid., 5-8. 54. Ibid., 12. 55. Ibid., 12-13. 56. Ibid., 37. 57. Ibid., 28-30. 58. Ibid., 13. 59. Ibid., 30-37. 60. Ibid., 6-7. 61. Ibid., 7. 62. Ibid. 63. “Chile Tax Policy,” PKF. Accessed October 28, 2013, http://www.claytonmckervey.com/attach/ worldwide-tax-guide-chile.pdf. 64. P. Mitchell. “Taxation and Investment Issues in Mining,” OECD. Accessed November 18, 2013, http://www.oecd.org/site/devaeo10/44282904. pdf. 65. M. R. Agosin, C. Larraín and N. Grau. “Industrial Policy in Chile,” IDB Working Paper Series. Accessed August 9, 2013, http://idbdocs.iadb.org/ wsdocs/getdocument.aspx?docnum=35472108. 66. “Tax Evasion: Pressure to End Tax Evasion Grows as the Global Forum Publishes New Reviews,” Newsroom Organisation for Economic Co-operation and Development. Accessed November 5, 2013, http://www.oecd.org/newsroom/ axevasionpressuretoendtaxevasiongrows astheglobalforumpublishesnewreviews.htm. 67. “Chile Must Combat Income Inequality, Despite Outlook – OECD,” Reuters. Accessed September 11, 2013, http://www. reuters.com/article/2013/10/23/chile-oecdidUSL1N0ID0RO20131023. 68. N. Marticorena. “Chile se ubica 36, entre 122 países, en ranking de capital humano,” El Mercurio. (2013, October 2). 69. N. Marticorena, “Chile retrocede en siete de los 10 principales rankings económicos de 2013,” El Mercurio. (2013, November 2). 70. M. R. Agosin, C. Larraín and N. Grau. “Industrial Policy in Chile,” IDB Working Paper Series. Accessed August 9, 2013, http://idbdocs.iadb.org/ wsdocs/getdocument.aspx?docnum=35472108. 71. “Drain or Gain?” The Economist. (2011, May

26). Accessed November 22, 2013, http://www. economist.com/node/18741763. 72. A. Nelsen and Cochrane. “In Search of Energy, A Booming Chile Chooses to Dam its Rivers,” TIME. Accessed November 8, 2013, http://content.time.com/time/world/ article/0,8599,2070816,00.html. 73. M. R. Agosin, C. Larraín and N. Grau. “Industrial Policy in Chile,” IDB Working Paper Series. Accessed August 9, 2013, http://idbdocs.iadb.org/ wsdocs/getdocument.aspx?docnum=35472108. 74. S. Nolen. “Mining Reforms Key to Chile’s Future,” The Globe and Mail. (2013, November 25). Accessed November 29, 2013, http://www. theglobeandmail.com/report-on-business/miningreforms-key-to-chiles-future/article15594254/.

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Heinz Journal, Vol. 12, Issue 2  

Heinz Journal, Vol. 12, Issue 2

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