Adjustment and social costs in Chile during the 1980s

Abstract

Traditional analysis of adjustment programs tends to underestimate the welfare costs because it assumes that a contraction of nontradable production will close the expenditure-income gap, while the resulting excess supply of tradables will automatically be exported. In Chile, however, tradable output contracted sharply, falling almost two-thirds as much as nontradable output. The conventional analysis also ignores the effect of adjustment on unemployment rates and on real wages. This paper argues that the adjustment measures of the 1980s were regressive even though the government was successful in targeting its expenditures toward the very poor during the period of fiscal retrenchment. Among the regressive adjustment measures were the subsidies to holders of dollar-denominated debt provided by the central bank. In addition, policies to reduce expenditures raised the unemployment rate over 26%, reduced real wages by 20% for almost five years, and reduced health, housing and education budgets by 20% per capita. Finally, the required real devaluation raised the cost of living for the poor.