OECD Economic Surveys: Chile 2022

Executive summary

After a strong recovery, growth has slowed down markedly

Chile’s solid institutions have successfully delivered macroeconomic stability. This has helped to weather three major shocks. In 2019, widespread social unrest revealed deep-rooted discontent with economic and social inequalities. In 2020, the Covid-19 pandemic took a steep toll on lives and livelihoods, and led to the sharpest contraction of economic incomes in 40 years. In 2022, the Russian aggression on Ukraine and global supply shortages exacerbated already strong inflationary pressures, with rising prices pounding hard on many families. High prices of oil imports have worsened external accounts.

On the back of exceptionally strong policy support, the economy recovered swiftly from the pandemic and has significantly overheated. The fiscal expansion reached its peak in 2021 when the economy had already recovered. In addition, three rounds of early withdrawals from individual pension accounts released liquidity worth around 18% of GDP to households. This resulted in overall support of 30% of GDP, which far overcompensated the loss of labour incomes caused by the pandemic (Figure 1). A resulting unsustainable consumption boom took an end in 2022, while fiscal policy consolidated sharply.

Figure 1. Policy support overcompensated income losses

Source: OECD calculations based on Central Bank of Chile.

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Inflation has risen to a 30-year high, fuelled by expansionary fiscal policy in 2021 and exacerbated by global supply constraints and the Russian aggression on Ukraine. This triggered a strong and timely monetary policy response (Figure 2). Inflation expectations, which had been solidly anchored for decades, rose significantly above the target. The pandemic policy response is leaving a strong mark on Chile’s traditionally deep financial markets. Pension fund withdrawals required funds to liquidate long-term assets in their portfolio and reduced financial market depth, at the same time as many households depleted their pension savings.

Figure 2. Inflation has risen

Source: Central Bank of Chile.

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Looking ahead, growth is projected to slow sharply (Table 1). In the near future, quarterly GDP contractions are likely to continue until the last quarter of 2022, as high inflation and rising interest rates curtail household purchasing power. Pre-pandemic employment levels will be recovered gradually, supported by ongoing hiring subsidies. Inflation will only return to the target in early 2024.

Significant underlying growth challenges will have to be addressed over the next years. Rapid population ageing will reduce Chile’s labour force, and with that the economy’s growth potential, despite a positive impulse from immigration. Productivity has been stagnant or even decreasing, and structural reform efforts have fallen short of what is needed to lift it. Without policies that boost productivity, the scope for further economic and social progress will be severely limited.

Table 1. Growth is projected to slow down

	2021	2022	2023
Gross domestic product	11.9	1.9	-0.5
Private consumption	20.5	2.1	-1.9
Gross fixed capital formation	18.0	-2.4	-1.8
Exports	-1.5	1.6	2.1
Imports	31.2	5.2	-1.4
Unemployment rate	8.8	7.8	8.0
Consumer price index	4.5	11.1	6.4
Headline fiscal balance (% of GDP)	-7.7	-0.1	-2.6
Public debt (gross, % of GDP)	36.3	38.2	40.9

Source: OECD Economic Outlook database.

Low competitive pressures in a number of sectors are one reason behind weak productivity. Lengthy and complex regulations and licensing procedures hamper entrepreneurship and competition (Figure 3). A comprehensive review of existing regulations and a wider recourse to “zero-licensing” schemes would facilitate entry and strengthen competition. Better funding for the competition authority could support its competition advocacy role, including through more market studies that take stock of competition bottlenecks.

Foreign competition is also hampered by regulatory barriers. These barriers affect specific areas such as cabotage transport and public procurement, but there is also scope for improving trade facilitation and simplifying border procedures. Exports remain dominated by natural resources.

Figure 3. Regulations are complex

Source: OECD Product Market Regulation database 2018.

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Overall spending on research and development and innovation is relatively low. Public support for innovation and technology upgrading is being strengthened to boost productivity. Looking ahead, innovation support could be better coordinated and aligned with strategic priorities such as sustainability. Regular impact evaluations would help to focus R&D spending on the most effective policy instruments.

Better social protection and more equal opportunities are key priorities

Covid-19 has reversed previous declines in poverty and inequality. Around one third of the population is economically vulnerable, meaning that they remain at risk of poverty, with few financial buffers to cushion themselves against adverse events. Income inequality remains high by OECD standards, while labour informality affects more than a quarter of the population.

The pandemic has highlighted significant gaps in social protection. There is a need for developing a better social protection system that does not differentiate between formal and informal workers. Ensuring some basic social protection coverage for all, including in pensions, health and unemployment insurance, while simultaneously reducing the cost of formal employment, would reduce labour informality.

Few people have adequate old-age pensions, owing to low contributions and contribution gaps due to informal employment. A recently established universal basic pension will significantly improve the level of pension benefits for many low-income earners. Income-support programmes are highly fragmented, and unifying social assistance programmes into a single cash benefit scheme will allow increasing coverage and benefits.

Social contributions may affect incentives for formal job creation, especially among low-income workers. Future pension reforms should pay particular attention to formalisation incentives, while raising pension replacement rates.

Education is key for reducing inequalities and raising productivity at the same time. Learning outcomes remain well below the OECD average and pandemic-related school closures have exacerbated these longstanding challenges, as fewer students from vulnerable backgrounds used digital tools to remain connected. Expanding access to quality early childhood education would bridge early and often decisive gaps in cognitive and social progress and allow more women to work. Working conditions for teachers fall short of OECD average standards, with lower pay and longer working hours.

Tax revenues of only 21% of GDP are insufficient to meet rising social demands while preserving necessary public investment in infrastructure, education and health (Figure 4). Personal income taxes, which only 20% of Chileans pay, are one explanation behind this low tax collection. Raising public revenues by 4 percentage points of GDP, as currently planned by the authorities, is ambitious but within reach through a comprehensive tax reform.

Figure 4. Tax revenues are low

Note: LAC is a simple average of ARG,BRA,CHL,COL,CRI,MEX, PER. Source: OECD, Global tax revenue database.

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Fostering sustainable growth

A legally-binding long-term strategy for climate mitigation and adaptation aims at carbon neutrality by 2050 and is expected to generate emission reductions before 2025, giving rise to a declining trend only slightly above the 1.5-degree-compatible pathway range.

Renewable sources currently account for 47% of electricity generation, after a steady decline of the role of fossil fuels as solar and wind energy have gained importance. This development is set to accelerate over the next decades (Figure 5), to exploit a unique potential in the generation of electricity from renewable energy sources, estimated at over 70 times of current electricity supply. This makes Chile well-placed to produce and export green hydrogen, which is the only technology known so far that can decarbonise some hard-to-abate processes in heavy industry.

Despite this potential in renewables, coal combustion remains a major source of electricity today. Plans to phase it out by 2030 are ambitious but necessary and will reduce energy-related emissions. Transport-related emissions are set to decline through the electrification of the vehicle fleet, with new vehicle sales restricted to zero-emission models as of 2035.

Carbon prices remain distant from international best practice. The current level of the carbon tax is too low to promote renewable energy sources and the low carbon price hampers the development of an emission-trading scheme. Potential effects of higher carbon prices on low-income households could be mitigated through targeted cash transfers, building on recent success in this area.

Figure 5. Renewable energies have potential

Source: International Energy Agency, Ministerio de Hacienda.

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Main findings and key recommendations

 

MAIN FINDINGS	KEY RECOMMENDATIONS
Refining macroeconomic policies and reforming taxation
Inflation has risen to above 14 percent and inflation expectations over a 2-year horizon now exceed the inflation target, despite timely monetary tightening.	Maintain a restrictive monetary policy stance to ensure the return of inflation to target.
Public debt has risen, the economy has recovered strongly from the pandemic-related downturn and inflation has risen significantly above target.	Keep the pace of fiscal consolidation in line with current fiscal plans, including a strong reduction of public expenditure during 2022.
The current tax intake of 21% of GDP is insufficient for achieving sizeable improvements in social protection and public services such as health and education, and for achieving more inclusive and sustainable growth in the future.	Mobilise additional tax revenue through a comprehensive reform of personal income taxes, property taxes and improvements in tax administration.
The fiscal rule has failed to prevent a rise in public debt and lacks a formal escape clause, leaving details about departures from the rule undefined.	Enhance the fiscal rule with a debt anchor and an escape clause that defines conditions for departing from it, and a trajectory to return afterwards.
Traditionally deep financial markets have been affected by extraordinary pension fund withdrawals, resulting in shorter maturities and higher rates.	Ensure that part of future pension contributions are saved and invested in the capital market.
Strengthening productivity and competition
Lengthy and tedious municipal licensing procedures continue to hamper entrepreneurship and competition. Research and development spending is low.	Streamline and unify municipal licensing procedures and foster the digitalisation of relevant procedures.
Many regulations may have become obsolete and digitalisation provides plenty of opportunities to reduce compliance costs.	Review the stock of existing regulations and their impact on competition. Move towards “zero-licensing” schemes wherever possible.
The competition authority has been undertaking market studies of key sectors, which revealed significant need for action.	Ensure an adequate budget for the Competition Authority, in particular for the funding of market studies.
Support for research and development is fragmented into several programmes which lack systematic and regular evaluations.	Enhance R&D support focusing on the most effective programmes, maintaining a balanced mix between direct support and tax credits.
Strengthening social protection and job quality
Informal employment affects 25% of workers. This precludes them from access to many social security benefits, while reducing productivity and tax revenues.	Establish a comprehensive strategy to foster formalization, including lower non-wage labour costs, better skills, stronger enforcement and improvements in tax administration.
The pandemic has highlighted significant gaps in social protection, particularly for informal workers. Income-support programmes are highly fragmented.	Consider merging existing cash transfer programmes into a single conditional guaranteed minimum income scheme.
Low-income pensions have improved due to a novel guaranteed minimum pension, but many middle income earners and women have inadequate old-age pension levels. Higher mandatory contributions raise the cost of formal job creation, driving many low-skilled workers into informality.	Consider raising pension levels and applying a progressive contribution rate schedule, ensuring strong incentives for formal job creation.
The public health system covering the disadvantaged population is underfunded, while private insurers select the lowest risk individuals Formal workers pay contributions for public healthcare, while informal workers don’t have incentives to contribute as they get almost the same benefit package for free.	Improve universal access to quality healthcare services by pooling existing resources and distributing them more equally across insurance schemes, with stronger recourse to general taxation revenues.
Improving opportunities and outcomes in education
Early childhood education is key for improving learning outcomes later in school, but funding is highly unequal across institutions. Female labour market participation is low, partly due to a lack of care facilities.	Expand access to early childhood education to all children from age three. Expand the central government funding of pre-school educational institutions that are not managed by the central government.
The training system is only weakly aligned with labour market needs and vulnerable workers find it difficult to access training courses.	Embark on a full revision of training programmes, including the tax credit, to increase the relevance and quality of training and improve targeting towards vulnerable workers.
Strengthening economic governance and the fight against corruption
Tender calls are meant to be the standard form of public procurement, but there are no clear rules when direct contracting can be used instead.	Clarify the rules for using tender calls in public procurement and strengthen compliance with these rules.
Chile has comprehensive regulations in the areas of lobbying, conflict of interest, financing of political parties and campaigns, but not all relevant information is publicly available.	Ensure that all members of government, congress and highest bodies of the judiciary submit their interest declarations without exceptions.
Making growth more sustainable and greener
Total emissions increased significantly between 1990 and 2018. Existing regulations are not always aligned with environmental objectives. The carbon tax is too low to promote renewable energy sources, which hampers the development of an emission-trading scheme.	Accelerate progress in decarbonising the economy through more stringent regulations and more consistent price signals, using both carbon taxes and cap and trade systems, while protecting the purchasing power of vulnerable households.
Chile has a strong potential for renewable energy generation. Power plants using renewable energy sources currently pay the same carbon tax per output as those generating carbon emissions.	Consider accelerated exemptions for power plants using renewable energy sources from the carbon tax.