Economic Reforms, Financial Development, and Growth: Lessons from the Chilean Experience

Type:
SCID Working Paper 238

Author(s):

Published:
01/1/05

Region:
Latin America

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Abstract:
Despite the reform effort of the past decade, the economic and social performance of Latin American countries during the 1990s was quite disappointing. The exception was Chile, which grew at a rate near 7% for most of the decade and reduced its poverty rate significantly. This paper tries to explain this striking difference. Following the most recent literature that highlights the role played by institutions and policies on growth, we argue that Chile's better performance was due to the country undertaking reforms that were much deeper and broader in scope than those in other Latin American countries. In the process, Chile ended up with stronger macro fundamentals and, most important, better institutions. Based on a cross-sectional econometric model estimated over the 1969-2000 period, we argue that Chile's better performance can be explained by the country's better institutions and better policies in equal shares (in contrast, East Asia's better performance is explained mainly by better economic policies). In addition, time series estimations show that Chile's 1981 pension reform and 1986 banking sector reform were critical to foster the development of the financial sector and thus accelerate economic growth. We conclude that, in order to attain higher growth, Latin American countries should move forward in their reform processes and put more emphases on building and strengthening their institutions, which, based on Chile's experience, can be modified (albeit slowly).