Idb - Country Strategy With Chile

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DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANKREGIONAL OPERATIONS DEPARTMENT 1

CHILE

COUNTRY STRATEGY

2006-2010

This paper was prepared by a team consisting of Cintia Guimaraes (RE1/OD1), Pablo Molina(RE1/OD1), and Juan Pablo Valenzuela (consultant). Inputs were provided by Felipe Gmez-Acebo (RE1/FI1), Nicols Uauy (RE1/FI1), Carmia Albertos (RE1/SO1), Toms Engler(RE1/SO1), Carlos Herrn (RE1/SO1), Huscar Eguino (RE1/SO1), Gabriel Montes(RE1/EN1), Adela Moreda (RE1/EN1), Paolo Valenti (RE1/SC1), Francisco Meja (RE1/SC1),

Mauricio Mesquita-Moreira (INT), Juan Blyde (RE1/RE1), Eduardo Rojas (SDS/SOC),Ezequiel Cabezn (RE1/OD1), Diana Arteaga (RE1/OD1), Jorge Martnez Riva (COF/CCH),Gloria Coronel (COF/CCH), Francisco Lois (COF/CCH), Jorge Venegas (COF/CCH), BeatrizLpez (RE1/SO1), Robert Daughters (SDS/SGC), Patricio Daz (COF/CCH), Mnica Rubio(RE1/SO1), and Edson Mori (PRI/OP1).


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CONTENTS

EXECUTIVE SUMMARY

I. KEY CHALLENGES TO ENHANCE SOCIAL EQUITY AND LOCK IN ECONOMICGROWTH ........................................................................................................................... 1

A. Background ............................................................................................................ 1B. The chief challenges to close development gaps with the advanced

economies............................................................................................................... 21. Reduce opportunity gaps ............................................................................... 22. Reduce the competitiveness gap with the developed economies ................ 33. Make government more efficient and bring it closer to the citizenry.......... 5

C. Medium-range prospects for economic and social progress................................ 61. The governments agenda.............................................................................. 6

2. Macroeconomic outlook ................................................................................ 8

II. CHIEF LESSONS LEARNED IN IMPLEMENTINGPREVIOUS COUNTRY STRATEGIES ........ 10

A. IDB financial relations with Chile, 1990-2005................................................... 10B. Strategy programming cycles in the last decade................................................. 11C. IDB funding to Chile: Portfolio characteristics and performance ..................... 11D. Lessons learned .................................................................................................... 13

III. THE BANKS STRATEGY WITH CHILE FOR2006-2010...................................................15

A. Objective............................................................................................................... 15B. The main actions to address the challenges ........................................................ 16

1. Reducing opportunity gaps.......................................................................... 162. Reducing competitiveness and income gaps with the developed

economies.................................................................................................... 193. Making government more efficient and bringing it closer to the

citizenry....................................................................................................... 254. Crosscutting issues....................................................................................... 29

IV. IMPLEMENTING THE STRATEGY ..................................................................................... 30

A. Fiduciary risk status ............................................................................................. 30

B. Toward a new business model for IDB operations with Chile .......................... 31C. Country financing parameters ............................................................................. 33D. IDB exposure........................................................................................................ 33E. Lending scenarios for 2006-2010........................................................................ 34F. Support to the private sector ................................................................................ 34G. Strategy implementation risks ............................................................................. 35H. Country dialogue agenda ..................................................................................... 35


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TABLES

Table 1 Chile: Indicators

Table 2 Active operations and execution status at 15 October 2006Table 3 Country financing parameters

FIGURES

Figure 1 Evolution of public-sector debt to the IDB and undisbursed public-sectorloan balances

ANNEXES

Annex I IDB operations program in Chile 2006-2010Annex II Millennium Development GoalsAnnex III List of documents used as inputs in developing the Banks country strategy

with ChileAnnex IV Nonlending products programAnnex V Management actions addressing OVEs recommendations in its Chile

country program evaluation: 1995-2005.Annex VI IDB country strategy with Chile: Consultation process and dialogue

Annex VII Country strategy monitoring indicatorsAnnex VIII References


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ABBREVIATIONS

CASEN National Socioeconomic Survey

CCLIP Conditional Credit Line for Investment ProjectsCFAA Country Financial Accountability AssessmentCGR Office of the Comptroller General of ChileCODELCO Corporacin Nacional del Cobre [Chilean Copper Corporation]COF/CCH IDB Country Office in ChileCPAR Country Procurement Assessment ReportDIPRES Budget Directorate, Ministry of FinanceECLAC Economic Commission for Latin America and the CaribbeanGDP Gross domestic productIIRSA Initiative for the Integration of South American Regional InfrastructureITC Information and communications technologies

MERCOSUR Southern Common MarketMIP Management improvement programMSMEs Micro, small and medium-sized enterprisesNIS National innovation systemOECD Organization for Economic Cooperation and DevelopmentPROPEF Project Preparation and Execution FacilityPRI IDB Private Sector DepartmentPRODEV Program to implement the external pillar of the Medium-term Action Plan

for Development EffectivenessR&D Research and developmentSENAMA National Bureau for Older Adults

SERNATUR National Tourism ServiceSMEs Small and medium-sized enterprisesSUBDERE Regional and Administrative Development Department, Ministry of the

InteriorUNDP United Nations Development ProgrammeWB World Bank


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EXECUTIVE SUMMARY

Over the last 20 years Chile has posted high growth rates, kept its macroeconomy stable,and systematically reduced poverty. While steadily opening up its economy it continued itsState modernization efforts. But despite impressive advances in those spheres the countrystill has some enormous challenges to manage if it is to catch up to the more advancedeconomies development level.

Even though Chile cut its poverty rate in half between 1990 and 2003from 38.6% to18.8%, its income distribution is one of the most uneven among countries at a comparabledevelopment stage, with virtually no improvement since the 1960s. Furthermore, thepopular perception in Chilean society is that family background counts more than personalmerit in deciding the opportunities an individual will have to better his or her lot (UNDP,2004), and education, ethnicity, and geography overwhelmingly determine a personssocial mobility prospects. Thus, while healthy economic growth rates are a must to combat

poverty, Chile has seen that they are not enough to achieve more equitable development.

Though the economy grew 5.7% annually, on average, between 1990 and 2004, Chileansper capita income is barely 30% of the U.S. figure and 40% of the OECD average. Theproductivity gap with the advanced economies is even wider than the income gap. Thissituation presents an opportunity and a strategic challenge for the country, since it suggeststhat productivity increases should be the chief tool to achieve lasting economic growth.

Much of Chiles economic and social progress in the past 15 years can be ascribed to thequality of its public policies and strengthening of the State and to successful public-privatesector coordination and partnering. This has helped earn it a place among the top-scoring

countries for quality of public administration in the World Economic Forums 2005ranking. But there still are major challenges in the State reform sphere, notably tostrengthen subnational government institutions and management and to engage citizensmore in public policy development and scrutiny. These elements are important both toimprove the quality of territorial governance and to ease some sharp regional and localsocioeconomic development disparities across the country.

The Bachelet administration has unveiled its plan to usher in a new chapter in Chilesdevelopment. Recognizing what the country has achieved since 1990, the governmentproposes to bolster the social safety net, further develop social inclusion policies, createconditions to propel economic growth, strengthen government-citizen relations, and

improve Chileans quality of life.

Having tightly aligned its Chile country strategy to the new administrations statedpriorities, the Bank proposes to be a strategic partner to help the country meet its keychallenges as it approaches its 2010 bicentennial, selecting target areas and issues wherethe Bank can deliver significant value-added. As its first challenge the Bank intends to helpChile reduce opportunity gaps, focusing its support on such areas as expanding earlychildhood education and improving the quality of Chilean education, reducing poverty, and


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bolstering the social protection system, including a package of measures to improve thepension system. Initiatives to promote inclusion and develop policies and programstargeting the countrys most vulnerable groups would come in for support as well.

A second challenge will be to help Chile reduce competitiveness and income gaps withthe developed economies. Here the Banks support targets will be innovation andtechnology development as key for raising national productivity; a new cycle of regulatoryreforms and, as a special focus of attention, strengthening of medium- and long-termenergy securitya concern that is creating great uncertainty as far as prospects for strong,lasting growth are concerned. The Bank also would support capital market strengthening,production capacity increases in micro, small, and mid-size enterprises, and strengtheningof the external sector in areas that hold good potential for Chiles sustainable development,such as agricultural development, the tourism sector, and strengthening of environmentalsustainability.

As a third challenge the Bank proposes to assist Chile to make government more efficient

and bring it closer to the citizenry. It will focus on areas in which it already has amassedvaluable experience in Chile and elsewhere in the region: fostering territorial developmentand creating institutional conditions for its sustainability; devising more and bettermechanisms for accountable and participatory governance, and improving nationalgovernance.

These key challenges thus make it possible to propose an articulated strategy for thecountrys development aimed at achieving greater economic and social opportunities toincrease development opportunities for all Chileans and strengthening the level of equityand integration by reinforcing democracy, citizenship, transparent governance.

Given Chiles development status, its prospects for continuing fiscal surpluses in the shortand medium term, and its access to a wide range of international finance options, it isbecoming more and more selective about the kind of support it seeks from the Bank,looking now to areas in which the Banks involvement offers a clear comparativeadvantage and can contribute high value-added. Since opportunities and challenges in Chileare constantly evolving the Bank will need a flexible strategy and a continuous learningprocess to be able to respond promptly to the countrys needs. With these considerations inmind and drawing on lessons learned from its work in Chile, the Bank is instituting a newbusiness model for its operations in the country, built on three action pillars: (i) identify andexpeditiously develop emerging windows of opportunity; (ii) make Bank loans moreattractive, which will require lowering the transaction costs of Bank operations in Chile,

concentrating new lending in the country in local currency, and coordinating thecontribution of the Banks private sector arm in the multiple opportunities the countrypresents, and (iii) manage the portfolio for results and disseminate lessons learned, in Chileand across the region.


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I. KEY CHALLENGES TO ENHANCE SOCIAL EQUITY AND LOCK IN

ECONOMIC GROWTH1

A. Background

1.1 Thanks to macroeconomic policies2 and structural reforms brought in over the lasttwo decades Chile has achieved robust economic growth rates, kept itsmacroeconomy stable, and systematically reduced poverty. A chapter of strong,sustained growth (1985-1997) was followed by a slower-growth period (1998-2003) which drove down employment levels, in part a spillover from the globaleconomic downturn triggered by the Asia crisis (1997-1998). Between 1985 and1997 the economy expanded 7.1% annually, far outpacing historical rates;3 in 1998-2003 the annual growth rate was barely 3.1%.

1.2 Chiles economic rally in 2004 and 2005, featuring growth rates of 6.1% and

6.3% respectively, was fueled by buoyant international conditions which set worldgrowth records and sent copper prices skyrocketing, but also by factors at homearising investment rate and a series of fiscal and financial reforms put through duringthe Lagos administration (2000-2006). These factors, plus the new opportunitiesopening up for Chile under multiple trade accords with the leading globalproduction centers, augur well for lasting economic recovery and make the countrymore resilient to any eventual global economic downturn.

1.3 Different estimates put Chiles growth potential at around 5% annually. Such anincrease would mean a 4% annual rise in per capita income, enough to double thecurrent figure in 20 years and approach some advanced-nation income averages.

Chile stands out in the region not just for its good macroeconomic management andsustained growth rates but also for its successful entre into the global marketplaceand a set of social policies that couples economic growth with a determined attackon poverty. Between 1990 and 2003 the poverty rate fell from 38.6% to 18.8%; theindigence rate from 12.9% to 4.7%. But Chiles high income inequality indexeshave remained virtually unchanged since the 1960s, leaving it with one of the mostuneven distributions among comparable-income countries.4

1

The diagnostic assessment in this section draws on the Policy Dialogue Paper Desafos hacia elBicentenario (IDB, 2006) and a set of 11 Technical Notes delivered to the new authorities inMarch 2006.

2 Over this span Chile combined fiscal austerity with strong doses of exchange rate flexibility and tradeliberalization. More recently, this system was complemented by an inflation targeting system operatedby an independent Central Bank and the unveiling of a rule or policy commitment mandating apredetermined structural surplus.

3 The Chilean economy grew 3.2% annually in the twentieth century.4 United Nations Human Development Report 2005 (UNDP, 2005).
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B. The chief challenges to close development gaps with the advanced economies

1.4 Though Chilean society has made huge progress, the country is aware of theimperatives it needs to address to catch up to the more advanced economiesitsprime medium- and long-range goal. The following section discusses some of thekey challenges the Bank visualizes for the coming years, for which it could lendsupport.

1. Reduce opportunity gaps

1.5 Chile was able to keep up a 5.7% average annual growth rate between 1990 and2004 and achieved the largest poverty and indigence rate reductions in the regionduring those years (ECLAC, 2004), but differences in individuals socioeconomicstatus and family background heavily influence how opportunities are shared inChilean society. Education, ethnicity, and geography are some of the main

determinants of inequality in the country (U. de Alcal, 2005; Santibez, 2006).

1.6 Chronic, gaping income inequality is one manifestation of this. In 2003 ChilesGini coefficient for pre-transfer household income was 0.57, placing it toward thebottom of the ranks of comparable-income countries for pre-transfer incomedistribution, and trailing at a distance countries with production patterns similar toChiles (primarily natural resources-based) such as New Zealand (0.36), Australia(0.35), or Canada (0.33) (Human Development Report, 2004).5

1.7 Achieving greater equality of opportunities is a very complex challenge for Chile,since there has been no improvement in its high income concentration since the late

1960s; even in the past 15 years the income share of the wealthiest 1% ofhouseholds has been climbing. This same pattern of heavy concentration ofpersonal development opportunities shows up in its intergenerational behavior: forexample, a mere 4% of the current Chilean elite were born into the lowersocioeconomic bracketsnine times lower than the German figure (UNDP, 2004).An income analysis shows that just 6% of children whose fathers were in the40% of lowest-income households in their generation now form part of thewealthiest 20% of households. That rises to 50% if the father was in the wealthiest20% of his generation. Some early studies indicate that progress in incomedistribution is expected in the new generational cohorts (Sapeli, 2005; Nuez andRisco, 2005).

1.8 This opportunity gap has made for highly inequitable development in Chile. Thepicture is even worse when one looks at territorial components: output and incomeare heavily concentrated in a handful of regions, cities, and municipalities, and

5 This extreme inequality is somewhat attenuated through government social policy, by virtue of whichthe ratio of income of the top quintile to the bottom quintile has fallen from 14.3 to 7.6 (Ministry ofFinance, 2004).


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subnational government institutions are underdeveloped. Consequently, in the last20 years Chiles economic performance has tended to create winner regionsamong them northern Chile and the Metropolitan Region, and others that are

structurally disadvantaged, like regions VII, VIII, IX, and X (Universidad deAlcal, 2005).

1.9 Increased access to preschool education6 and early stimulation of low-incomechildren are top priorities to reduce the structural causes behind the currentopportunity gaps for future generations (IDB Poverty Report, 2006; World Bank,2006). This will have the further benefit of facilitating more and better workforceparticipation of these childrens mothers.7 Early stimulation and preschooleducation are determinative to improve the quality of childrens basic andsecondary education outcomes, to operate as a strategic driver of greateropportunity for a new generation of Chilean children and youth. Another imperativewill be to enhance basic and secondary education quality and improve and developthe current facets of the social protection system and targeting of the mostvulnerable groups, with special attention to low-income children under four,indigenous communities, people with disabilities, and older adults.

2. Reduce the competitiveness gap with the developed economies

1.10 As Chiles development level continues rising, moves to increase opportunities andenhance equity will need to be underpinned by strong, sustained economic growth,to make reductions in the opportunity gap sustainable and accomplish theseimprovements within timeframes that Chileans consider reasonable.

1.11 The 1990s saw a dramatic rise in per capita GDP growth in Chile. Its 4.8% percapita annual increase was 3 percentage points higher than the rest of LatinAmerica, 2.5 points above the U.S. level, almost a full point higher than the EastAsian economies,8 and more than 3 points ahead of the rest of the world(De Gregorio, 2004). Though the average annual increase slipped to 2.5% between2000 and 2004, it still topped those country group averages, with the exception ofEast Asia.

1.12 According to an analysis of Chiles growth drivers, physical capital accumulationhas been the chief engine of its rapid growth. However, in total factor productivitythe country still trails the advanced economies at a distance, which suggests that

there is huge potential for increasing its contribution to growth. An analysis of

6 Though it climbed from 21% in 1990 to 35.1% in 2003, the preschool enrollment ratio still is low(Marcel and Tokman, 2005).

7 When women have good-quality child care options they can obtain more stable, higher-payingemployment in the formal sector (Perticara, 2005).

8 China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand.
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return to investment in physical capital comes to a similar conclusion. Generally, ahigh capital accumulation rate reduces returns to investment if the investment doesnot go hand in hand with substantial productivity increases. The risk is that a

reduction in return to capital accumulation may ultimately slow future investmentand jeopardize the sustainability of growthwhich has been driven predominantlyand precisely by capital accumulation. In the long run, the sustainability of capitalaccumulation and, hence, of output growth will depend ultimately on the aggregateproductivity gains the country can achieve.

1.13 There is a consensus among Chileans that more production-system innovation andtechnology development is the strategy of choice to boost national productivity(Larran, 2005; OECD, 2005; and Eizaguirre, N; Marcel, M., Rodrguez, J;Tokman, M., 2005). This would call for policies to encourage the use of betterforms of production in every sector of the economy, and new technologydevelopment for selected sectors in which Chile is already very globallycompetitive, such as the forest industry, salmon culture, or mining. To achieve thatobjective Chile would need to considerably raise its low innovation anddevelopment expenditure as a proportion of GDP (currently just 0.7%), boostingthe private sectors share in that investment and forging links between researchcenters and the production sector.

1.14 Increasing secondary and postsecondary education enrollment ratios,9 improvingeducation quality generally,10 and extending the reach of training and skillscertification programs are three ways to raise labor productivity. As an essentialadjunct, the private sectors leadership role in achieving higher, lasting increasesin economic productivity has to be underscored. The priority tasks that this will

entail are described in the Private sector development strategy developed by theBank11 in consultation with several leading Chilean private sector organizations.Preeminent among these tasks are the development of a set of policies to helpmicroenterprises and small and medium-sized businesses become moreproductive, thereby narrowing the current competitiveness gaps with largeproducing corporations and generating production linkages so these smallerbusinesses can position themselves more solidly in the global marketplace, andinitiatives to increase workforce participation, of women and youth particularly(IDB Poverty Report, 2006, and Zahler, 2005). Other prime focuses for improvingproductive efficiency are further development of Chiles capital market,strengthening of public utility regulation (Zahler, 2005, Gmez-Acebo and

9 In 2003 Chiles secondary school enrollment ratio stood at 92.6%, its postsecondary ratio at 37.5%(Marcel and Tokman, 2005).

10 In global measures of education quality Chile consistently scores lower than would be expected for acountry at its income level.

11 SeePrivate sector development strategy.
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Ketterer, 2005, Fischer and Serra, 2006), and better equipping the country toachieve medium- and long-term energy security.12

1.15 Boosting international trade will be one key to closing competitiveness gaps withthe advanced economies. This is fundamental in Chile with its resource-exportbased economic growth model. The main tasks going forward will be to: (i) furtherdiversify the countrys export basket; (ii) develop, propel, and generate conditionsto capitalize on the competitive advantages of each region, so that they can all profitfully from international trade; (iii) strengthen institutions and policies associatedwith Chiles mounting environmental commitments and ready them for potentiallymore stringent environmental requirements given the countrys stage ofdevelopment, its deepening international engagement, and a growing number ofcommitments under multilateral environmental accords and free trade agreements;(iv) significantly boost agrifood output in view of the sectors comparative,competitive advantage; and (v) work toward further integration with the rest of theregion (Mesquita Moreira and Juan Blyde, 2005; Quiroz, 2005; OECD, 2005),which complements the bilateral integration policy successfully carried out by thecountry.

3. Make government more efficient and bring it closer to the citizenry

1.16 Much of Chiles economic and social progress in the past 15 years can be ascribedto the quality of public policies and institutional strengthening of the ChileanState as well as successful public-private collaboration and coordination. Notableamong the reform focuses since 1990 have been: (i) fiscal balance, a moreindependent Central Bank, and concession laws, which had an immediate positive

impact on economic growth and price stability; (ii) public-utility regulation andthe protection-of-free-competition law, which was intended to create acompetitive playing field for businesses; (iii) reforms of the State and the judicialbranch, which laid the foundations for future improvements in economicperformance and social progress; (iv) changes in the health care system andcreation of the Chile Solidario system (targeting extreme poverty), which helpedenhance social equity; and (v) changes to labor system laws and environmentalprotection provisions to improve operating conditions in those sectors (Bensin,2005). A set of public management reforms brought in over that same span havehelped put Chile in the ranks of the highest-rated countries for quality of publicadministration (World Economic Forum, 2005).13

12 This diagnostic is echoed, in part, in the work of the Pro-Growth Agenda launched in 2001 to have theprivate sector work with government to identify growth-boosting opportunities.

13 The World Economic Forums 2005-2006 Competitiveness Index ranks Chile 22nd out of 117 countriesfor quality of public institutions. Its showing is particularly strong for public expenditure efficiency(19th in the ranking) and low levels of corruption in connection with exports and imports (7th place)and with public-utilities access (12th place).
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1.17 These impressive advances notwithstanding, strategic reforms still are needed toequip the State to achieve sustainable economic growth with equity, along withpolicies to enable the private sector to operate efficiently. Some important items

still on the reform agenda are: (i) the pension system, to increase competition andtransparency in pension system services; encourage moves to bring in workerscurrently not covered, especially the self-employed; review the institutionalstructure and incentives of pension system organization, especially in the publicsector; (ii) production-sector innovation; (iii) the labor market, to help makeemployment conditions more flexible and adjust social protection and trainingincentive systems; (iv) energy sector development; (v) capital market strengthening;(vi) strengthening of environmental protection; and (vii) improvements in judicial-branch administrative management and trade legislation (Bensin, 2005).

1.18 The main governance and State reform areas calling for future action will be:(i) strengthening of management control and budget systems of municipalgovernments and other decentralized central government agencies, and(ii) institutional design for territorial management, especially of cities,transportation, and infrastructure.

1.19 Though Chileans now have a stronger voice in how their economy and societyfunction, there is one unfinished item on the public agenda: devise and adopt amore systematic, global approach in that regard, to bring government closer to thecitizenry (Bensin, 2005). The two key challenges here are to: (i) engage citizensmore in public-interest decisions and in scrutinizing government institutionsperformance, and create a citizen rights ombudsman; and (ii) strengthen subnationalgovernment institutions and management, to deepen participatory democracy.

C. Medium-range prospects for economic and social progress

1. The governments agenda

1.20 The Bachelet administrations overarching goal is to answer Chileans call for anew chapter in their nations development. This will entail acknowledging theimpressive gains achieved since 1990, such as the entrenching of democracy,sustained economic growth, and a plummeting poverty rate, while managingserious challenges that will call for a new leadership and management style to beable to construct a more pleasant, inclusive society and a State that puts citizens at

the center, thereby strengthening participation, increasing the transparency ofgovernment operations, and making the State accountable to its citizens. The chiefchallenges the new administration plans to tackle in its 2006-2010 term are outlinedin the governments agenda paper and in President Bachelets message to the nationdelivered in the Congress on 21 May 2006.

1.21 The social challenge the new administration is taking up is to bolster the countryssocial safety net, which should protect Chileans against the most common risks to
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personal and household quality of life and cushion the severe toll that negativeshocks from elsewhere can take on an economy as globally integrated as Chiles.Aside from targeted programs and compensatory policies, this social reform would

aim above all to get beyond a vision of discrete programs in separate sectors toconstruct a network system giving the population access to the range of governmentservices and programs, ensuring minimum opportunities and rights, and dedicatingparticular attention to development of skills and opportunities so individual citizensand families can share in the fruits of progress. President Bachelet stated recentlythat during her administrations term in office there would be sweeping changes intwo social spheres: comprehensive social security reform, and education systemimprovements, with a focus on early childhood education and raising primary andsecondary education quality.

1.22 The government also plans to further develop social inclusion policies to eliminateall forms of discrimination, ensure human rights protection, foster developmentwith identity of the nations aboriginal communities, and promote Chileanscultural development.

1.23 In the fiscal and economic policy domain, the new administration is aiming forrobust, lasting economic growth by way of a new development policy that wouldsee Chiles development status on a par with some OECD countries by the end ofthe next decade. With the countrys current macroeconomic management andpublic-private coordination mechanisms as a starting point, that would meanidentifying new production areas and operating policies to spur innovation, newtechnology adoption, production linkages, and export development; charting a newstrategy to bolster micro, small, and medium-sized enterprises, and streamlining

and better coordinating government operations and services to propel businessdevelopment. Another facet of the plan is to seize the enormous opportunitiesafforded by the Chilean economys growing integration and economic globalizationand technology changes. Deeper integration with other countries in the region willbe one priority.

1.24 With regard to citizenship and personal quality of life, the new administrationproposes to bring government closer to the people by strengthening civil societyand furthering decentralization, opening more and better avenues for citizen inputinto public policy decisions. Increased transparency, reporting, and accountabilityof local, regional, and national authorities to the public and to civic organizations is

a central piece of the plan. To enhance quality of life the government is proposingapproaches that take in the different levels of government, the private sector, andthe citizenry to coordinate public policies and programs dealing with housing,security, transportation, infrastructure, and sports. Creating more pleasantneighborhoods that improve quality of life is an item high on the reform agenda.


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2. Macroeconomic outlook

1.25 The fiscal rule: Fiscal policy follows a methodology of structural balance, thegoal of which has been to generate a structuralcyclically adjustedconsolidatedcentral government surplus of 1% of GDP. This goal is structured such that thegovernment saves its CODELCO copper sales revenues above a reference price andtakes in more copper-related taxes from the private sector.14 The rule has beeninstitutionalized through the Fiscal Responsibility Act (Law 20128, approved inAugust 2006). Since record-high copper prices in 2005 and 2006 have left Chilewith sizable surpluses, at least during the life span of this country strategy itsexternal borrowing requirements are likely to be limited by virtue of this revenuewindfall.

1.26 Potential and medium-term growth: Actual growth forecasted for 2006 isestimated at 5%, which represents a drop with respect to 2004 (6.2%) and 2005

(6.3%). For 2007, however, growth is expected to increase to 5.7%, above thepotential GDP growth rate for the 2006-2010 period (5.3%). Growth rates areexpected to remain the same at the end of the period (Table 1). By Ministry ofFinance estimates, in the medium term the current account will balance (2009),with a fiscal surplus that will shrink as copper prices drop. In 2009, copper pricesare expected to be at half the 2006 price. Inflation will remain in the 3% range forthe 2006-2010 period.

1.27 Medium-term poverty reduction prospects: If coupled with a slight improvementin the income distribution, Chiles robust growth and solid control of keymacroeconomic variables could mean reductions in poverty and indigence rates.

Assuming different scenarios regarding per capita growth rates and marginalchanges in the income distribution (looking at the Gini coefficient), estimates wererun (IDB Poverty Report, 2006) of how long it would take Chile to halve thepoverty and indigence rates that came out in its most recent national socioeconomicsurvey (CASEN 2003).

1.28 With a 4% annual rise in per capita income and no change in the current incomedistribution it would take Chile nine years to cut the poverty rate to 9.4% and theindigence rate to 2.3% (i.e., the 2012 numbers would be half the 2003 surveyfindings). But if the country could bring its high Gini coefficient down a singlepoint it could achieve those targets by 2011 for poverty and 2010 for indigence,

given the strong poverty effect of evening out the income distribution.

1.29 In the best scenario2004-2005 growth rates and 2006 projections holding in2007-2009Chile could reach the above-mentioned target toward the end of the

14 Including revenues from sales of molybdenum, a byproduct of copper mining.
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new administrations term (2009), taking the country into its bicentennial year witha single-digit poverty rate.

Table 1. Chile: Macroeconomic Indicators

1983-

1997

1998-

20032004 2005 2006e 2007f 2208f 2009f

GDP growth (%) 6.8% 2.6% 6.2% 6.3% 5.0% 5.7% 5.5% 5.4%

Potential GDP growth (%)1 7.1% 4.1% 4.2% 4.9% 5.0% 5.3% 5.3% 5.3%

Inflation (%) 15.5% 3.2% 2.4% 3.7% 3.7% 3.0% 3.2% 3.0%

Change in exchange rate(% end of period)

12.5% 8.5% -6.6% -8.1% 4.1% 0.9% -1.3% -1.3%

Price of copper(US$/lb annual average)

0.95 0.75 1.30 1.67 3.05 2.75 2.40 1.48

Curr. acct. balance (% of GDP) -4.1% -1.0% 1.7% 0.6% 3.6% 2.2% 1.8% 0.0%Central govt. balance (% of GDP)2 2.1% -0.7% 2.1% 4.7% 7.6% 4.4% 1.1% 0.4%

1 The figures under the 1983-1997 column actually correspond to 1985-1997.2 The figures under the 1983-1997 column actually correspond to 1987-1997.Sources: Central Bank of Chile, Budget Directorate (DIPRES), IMF, and private sources


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II. CHIEF LESSONS LEARNED IN IMPLEMENTING PREVIOUS COUNTRY

STRATEGIES

A. IDB financial relations with Chile, 1990-2005

2.1 IDB financing for Chile since the early 1990s can be divided into four stages. Thefirst, from 1990 to 1993, saw numerous loan approvals for public-sector programsas the Bank helped the country tackle a host of challenges as democracy wasreinstated. However, in light of the economys stellar performance the centralgovernment elected to systematically reduce its external debt, thereby halving thedebt-GDP ratio from 19.1% in 1990 to 9.4% in 1994. In a second phase runningfrom 1995 to 1998 which saw sizable annual budget surpluses the governmentcontinued to pare the external debt stock. Ultimately it canceled loans from the IDB

and other multilateral organizations and prepaid a sizable share of the cumulativedebt to these agencies. All the programs that the canceled loans had been fundingproceeded as previously agreed with the Bank, the governments decision havingbeen prompted strictly by the countrys financial condition and not the programsquality or relevance.

Chile. Evolution of public-sector IDB debt and undisbursed public-

sector loan balances

-

500

1,000

1,500

2,000

2,500

3,000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Jun-06

Deb

t(US$m

illion

)

-

100

200

300

400

500

600

700

800

900

1,000

Un

disburse

d(US$m

illion

)

Debt (left axis)

Undisbursed (right axis)

2.2 During the third stage, 1999-2000, as the Chilean economy slipped into recessionand the public sector went heavily into deficit, the Banks support took the form offour loans totaling US$443.5 million. The fourth stage, from 2001 to 2005, whichbegan with the development of the Banks 2000-2006 country strategy, marked theclose of Chiles countercyclical relation with the Bank that had characterized the

1994-2000 chapter. The Banks main role now was that of strategic partner,targeting its support tosectors where it hadcomparativeadvantages. Between2001 and 2003 itapproved five newloans for public-sectorprograms. In 2004, asthe economy movedinto a new growth

phase, it approvedUS$25.7 million inloans for fourprograms, followed in2005 by US$40.6million for five newprograms. Over thisspan the Private Sector


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Department (PRI) and the Inter-American Investment Corporation (IIC)successfully executed a series of private sector operations. A succession oftechnical-cooperation operations (financed by the MIF and other funds) and

regional technical-cooperation projects also were approved over the 1994-2005period.

B. Strategy programming cycles in the last decade

2.3 In the decade of 1995 to 2005 the Bank produced two Chile country strategies. Thefirst of these roadmaps, covering 1996-1998, was developed at a time when thegovernment had canceled the bulk of its IDB loans; for the most part, the Bankdelivered support by way of technical-cooperation operations and promotedfinancial transactions with the private sector. That first strategy had a fourfoldfocus: (i) private sector productivity; (ii) economic and physical integration;(iii) environment and natural resources, and (iv) modernization of the State and

civil society. When it put together the subsequent strategy, for the period 2000-2006, the Bank was once again lending to Chile, having approved three sizable loanoperations. In that most recent strategy the Bank viewed its role as being Chilesstrategic partner in sectors in which it could offer comparative advantages. Anadded challenge was to develop direct lending operations to the private sector,which the previous country strategy had not achieved. The new strategy focuseswere similar to the ones pursued in the previous strategy but with a heavier socialemphasis. The strategy marked out three main action areas for the Bank:(i) competitiveness and integration into the new economy; (ii) reducing inequalityand enhancing quality of life; and (iii) modernization of the State and civil society.

C. IDB funding to Chile: Portfolio characteristics and performance

2.4 Four features stand out in the Banks 1995-2005 portfolio. The first is thepredominance of very complex projects, either because they were innovativeoperations for Chile (and at times for the Bank as well) or because of the largenumber of coexecuting agencies. Second, overall portfolio performance was good,though budget strictures or other project-specific factors did affect some operations.Third, there was a steady downtrend in the size of new approvals, Chiles prioritybeing technical assistance from the Bank rather than loans. And, fourth, transactioncosts for the country were high. Two points are notable in the latter area: (i) overthe last decade Chile solidified a transparent, high-quality government procurement

system (ChileCompra) which eventually became mandatory for all governmentprocurements except those pertaining to IDB-funded operations; and(ii) supervision or auditing by Chiles Office of the Comptroller General ofprocurement and disbursement processes was not considered sufficient for theBanks purposes, so it continued to review them.


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Table 2: Active operations and execution status at 15 October 2006*(US$ millions)

Operations in execution No. of operationsAmount approved

US$ millions

Amount approved

% portfolio

Amountdisbursed

US$ millions

% disbursed

Loans 16 219.46 54.8% 75.50 34.6%

Investment 14 218.41 54.6% 75.50 34.6%

PROPEF 2 1.05 0.3% - -

PBL - - - - -

PRI1 2 150.00 37.5% - -

MIF2 17 20.19 5.0% 3.52 17.4%

IIC3

Nonreimbursable TCs 32 10.48 2.6% 3.99 38.6%

Country specific 18 5.13 1.3% 1.38 27.7%

Regional 14 5.35 1.3% 2.61 48.8%

Small projects - - - - -

TOTAL 67 400.13 100% 83.01 20.75%

Source: RE1/OD1 based on LMS50 at 15 October 2006* Does not include IIC figures.1 Excludes PRI-B2 Includes regional MIFs assigned to CCH as the unit responsible for disbursement.3 Active portfolio, comprised of operations in the process of being disbursed, or already disbursed but not repaid.

2.5 Table 2 lists active IDB public and private sector operations at 15 October 2006.The following are features of the public sector operations: (i) the portfolio is young:the oldest of the current projects was approved in 2001 and 12 of the 14 operationswere approved between 2003 and 2005; (ii) several of the projects mark innovativeventures in such sectors as older adults, tourism, citizen security, indigenouscommunities, and digital economy; (iii) the Bank employed new lending modalitiessuch as multiphase programs, innovation loans, and the Project Preparation andExecution Facility (PROPEF); (iv) small loans predominate (only three approvalssince 2002 are for more than US$20 million); and (v) operations intended to reduceinequalities account for 63% of the total, programs supporting modernization of theState for 21%, and competitiveness operations for 16%. As for the private sector,

active operations are currently comprised of two PRI guarantees and various IICoperations for amounts of about US$8 million.


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D. Lessons learned15

2.6 An analysis of the Banks operations with Chile and the country programevaluation produced by the Office of Evaluation and Oversight (OVE) covering1995-2005 offer lessons to inform the Banks new country strategy for 2006-2010:

2.7 High transaction costs for Bank programs: Much of the administrative workcurrently being done to supervise Bank operations overlaps with what governmentagencies are doing. If this inefficiency can be reduced it will be simpler for Chile toexecute operations with the Bank and the associated transaction costs to bothparties can be lowered. This will be achieved through intensive use of Chileangovernment procedures. For operations funded by the Banks private sector arm itis essential to become more competitive, since Chiles sophisticated andcompetitive financial system offers the Banks prospective client base a broad rangeof business finance options. Transaction costs with the Bank are high

(environmental and financial requirements, hiring of external financial and legalexperts) and its loan processing and approval times are longerall of which puts itsignificantly behind the competition.

2.8 Flexibility in adding new country-work areas: Since 2001 the Banks relationwith Chile has been very dynamic, requiring the capacity to address thegovernments multiple needs in new sectors for programs that can bring the countryhigh value added. Programs supporting public building management, the digitalstrategy, citizen security, and strengthening of the Civil Service Directorate areexamples of the very varied and complex portfolio developed to date.

2.9 Country strategy preparation: The methodology adopted to craft the Bankscountry strategies and the strategy development exercise itself were more importantthan the end-document, especially for the 2000-2005 span, since they facilitated aparticipatory process to decide Bank priorities and development of countryownership of the strategy.

2.10 Independence from the fiscal cycle: Since 2001 Chiles relation with the Bank hasbeen independent of the fiscal cycle, centering instead on support to strategicsectors in which the Bank offers the country clear comparative advantages.Accordingly, the Bank now is administering a growing number of more complexand innovative programs, though loan amounts are smaller than in the portfolio it

was managing up until the early 1990s.

2.11 IDB value added for Chile: The Banks comparative advantages in this newrelationship with the country lie in the following areas: (i) operations design, with

15 See Lecciones Aprendidas por el Banco en Chile 1994-2004, IDB Technical Note, 2006, and OVE,Country Program Evaluation: Chile 1995-2005. Annex V lists the recommendations set out in thatcountry program evaluation and Managements ongoing or planned actions to address them.
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heightened citizen input or engagement of organizations associated with theprograms and the use of effective instruments to make a project better;(ii) operations management, providing for the design of cross-sectoral programs,

improving coordination arrangements and reducing the operations risk of failure;(iii) the possibility of meshing efforts of the central government or decentralizedpublic agencies with the private sector and/or civil society in strategic projects;(iv) the Banks technical expertise, built up in international experiences and in otheroperations in Chile; (v) the seal of quality the Bank provides, and (vi) thepossibility of piloting innovative ventures. A keynote of the Banks dealings withChile was the countrys strong leadership in program design and execution, theBank having acted as strategic partner and collaborator. This deep sense of countryownership of programs would warrant further innovations in how the Bankmanages its operations.

2.12 IDB local currency lending: Given the mounting foreign currency revenues of theChilean State and of the economy overall, the countrys external borrowingarrangements should be exchange rate neutral so as not to weaken the economysexternal competitiveness. For the Banks part it will be essential to develop localcurrency lending products for Chiles public and private sectors alike.

2.13 Success factors in IDB-funded programs: In addition to an executing agencysinstitutional capacity and prior experience in programs with the Bank, there are atleast four key drivers of good outcomes: (i) sound institutional design of programs;(ii) project executing units designed to continue as permanent fixtures within theexecuting agencies; (iii) early engagement of areas of government that can makethe programs sustainable, particularly municipal and regional governments; and

(iv) special use of certain Bank instruments such as PROPEF operations,multiphase programs, and midterm project reviews.

2.14 Challenges to deepen citizen and civil society organization engagement: One ofthe Chilean States overarching objectives is to engage citizens and civil societyorganizations more in public programs and policies. In keeping with that aspiration,most of the Banks new operations in Chile have had participatory components ofdifferent kinds, incorporating a learning process for the redesign of governance. Butbuilding such an approach into government actions sometimes increases their costand implementation times, especially owing to the procedural-redesign learningrequirements. Hence, the fact that the programs will be more complicated to run,

will take time to yield results, and will require continuous discussion and learning isan important consideration in program planning.

2.15 Potential for support to the private sector: The kind of operations that PRI andthe IIC have been funding in Chile since 2001, and the MIF for longer, indicatesthat there are some large windows of opportunity through which the Bank can addvalue in private sector development and public-private collaborations. The Banksinfrastructure concession guarantees are one example.


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III. THE BANKS STRATEGY WITH CHILE FOR2006-2010

A. Objective

3.1 The aim of the Banks 2006-2010 country strategy with Chile is to help the countrypursue growth and, in particular, improve equality of opportunity and ensure thesocial inclusion of vulnerable population groups.

3.2 This new strategy proposal has been constructed in a context of Chiles sustainedeconomic and social gains and world-class macroeconomic management and thenew administrations agenda of strategic priorities and reforms. Given thisbackdrop, what the Bank has learned in the past 10 years of work with Chile, andexpectations as to the countrys sound financial and fiscal condition in the coming

years, the Bank will have to operate a fairly flexible strategy to accommodateprojects and initiatives that can articulate the challenges already identified and fitwith the areas discussed in this paper and others that address new requirements oropportunities in the public or private sector.

3.3 The strategy set out here proposes selective actions in strategic areas for Chile, witha good measure of flexibility for operations selection, design, and execution,employing the new lending instruments available and tightening country-workcoordination across the Bank group. As the Bank pursues this strategy it will beapplying its new business model in Chile, which is designed to improve themanagement and efficiency of its work and focus on value-adding components. Thepriorities will be to scale up work with territorial governments and the privatesector and implement innovative initiatives that call for the public and privatesectors to work in concert.

3.4 The 2006-2010 strategy is the product of a collaborative effort of the Bank and thecountry and of a dialogue opened in 2005 that saw consultations organized withgovernment officials and stakeholders from the private sector, the academiccommunity, and economic research centers (see Annex VI). The considerableanalytical work that went into the exercise looked at Chiles chief medium-termchallenges and alternative action avenues. The 16 studies produced included aprivate sector development strategy (see Annex III); their main findings wereconsolidated in a Policy Dialogue Paper and a set of 11 technical notes. The

dialogue has been deepening since the March 2006 special policy dialogue missionwhich featured discussions on childrens issues, pension reform, education quality,regional development, tourism, and other topics.
http://re1/roadmap/Docs/CHILE/Documento%20Dialogo/Dialogo%20de%20Politicas%2020MARZO.pdfhttp://re1/roadmap/Docs/CHILE/principal.htmhttp://re1/roadmap/Docs/CHILE/principal.htmhttp://re1/roadmap/Docs/CHILE/Documento%20Dialogo/Dialogo%20de%20Politicas%2020MARZO.pdf


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B. The main actions to address the challenges

1. Reducing opportunity gaps

3.5 The perception among Chileans is that, in their society, personal developmentopportunities are determined more by the family one is born into and by incomebracket than by personal merit. This perception is reinforced by the countrysincomplete social safety net which is too weak to help individuals and familiesmanage socioeconomic risks such as unemployment, old age, or catastrophicillness.

3.6 That diagnostic would make Chiles core development mission in the coming yearsthat of enhancing equity and developing opportunities for all, especially groups thatare far from partaking fairly in the fruits of progress. The aim is not just growthwith equity but also pro-growth pro-equity efforts. Over the span of its 2006-2010

country strategy the Bank could work with Chile to narrow opportunity gaps onthree main fronts:

a. Close education opportunity gaps and improve education quality

3.7 Raising education quality and improving education equity is a countrys bestavenue toward equity enhancement and equal opportunity for new generations. Thegovernment will be focusing strongly on improvements in early childhoodeducation, comprehensive support and services for children under four, andeducation quality.

3.8 The Bank will target its assistance to education quality improvements andimplementation of the childrens policy proposed by the Presidential AdvisoryCouncil on childrens policies, created by President Bachelet, particularly to help:(i) extend the reach of early childhood education programs and services;(ii) strengthen the cross-sectoral perspective in childrens policies; (iii) develop andsupport cost-effective nonformal service alternatives; and (iv) revamp educationsystem institutions and the sectors normative framework.

b. Lower poverty rates and bolster the social safety net

3.9 Even though Chile cut its poverty rate in half between 1990 and 2003 and roughly70% of all government expenditure has been going to social programs and services,close to one in five Chileans is still living in poverty. Furthermore, Chileans whofind themselves facing one or more of a set of social risksunemployment,catastrophic illness, old age, or workplace accidents being some of the mostcommonare very likely to slip below the poverty line, and some families trappedin structural poverty cannot improve their lot without help. As these social riskshave come to be acknowledged Chile has steadily woven a social safety netintended to cushion the economic and social toll of such hardships. Though thissocial protection system is continually being bolstered (for instance through the


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Explicitly Guaranteed Universal AccessAUGE program, Chile Solidario, andseverance insurance) it will be a major challenge for the country to expand it furtherin the coming years, mostly to deliver essential social services to large population

groups who are slipping through the current net, such as the self-employed, youth,and indigenous people (IDB Poverty Report, 2006), and to coordinate the multiplefacets of social policy so as to extend a true safety net under the population. TheBank could lend support in the following specific areas:

3.10 Pension reform: There are structural and institutional dysfunctionalities in Chilespension system, some of which arise from the job market. The structural problemshave to do with the systems effective coverage and financing, the institutional oneswith its governance system, basic information organization, and compliance andoversight. According to currently available data on the system coverage problem,close to 40% of the workforce is not contributing regularly to a personal pensionaccount and replacement rates are below expectations. Workers withnoncontributory pensions and pensioners drawing the minimum pension or less areabout half the number insured with pension fund management companies. Sincemodernizing the countrys pension system is so important the currentadministration has made this one of its four key reform pillars. The Banksassistance would center on technical support for development and implementationof Pension Reform Commission proposals.

3.11 Strengthening the social security system: By way of technical assistance theBank could help Chile to redesign the social insurance system, support governmentsocial security institutions, and improve selected facets of the system, such asunemployment insurance.16

3.12 Increasing female workforce participation: The Bank can continue to work withChile on strategies to increase female workforce participation, especially in thelowest income quintiles. Important strategy focuses would be to: (i) expand anddiversify preschool child care and preschool education services, primarily for thepoorest and most vulnerable children and households where the woman has to orwishes to work; (ii) develop more flexible workday policies; (iii) change maternityleave, special child-related leave, and maternity allowance rules; (iv) promote acultural change regarding parental, family, and community involvement andcommitment to recognize the importance of early childhood education; and(v) foster female entrepreneurship (SMEs).

16 The authors have drawn here from the Inter-American Development Bank paper authored by Cowanand Micco (2005).
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c. Promote inclusion of vulnerable groups and develop policies and

programs targeting those populations

3.13 A third action focus to lower Chiles current poverty rate and close opportunitygaps in its society is the inclusion of population groups which, for a variety ofreasons, are outside the mainstream and highly vulnerable and find it particularlydifficult to secure a fair share of Chiles development gains. This shows up in theirdeeper poverty or in the greater roadblocks they encounter to participate andexercise their rights. The Bank has amassed a wealth of experience in Chile in areasconcerning indigenous communities, people with disabilities, older adults, andcommunities affected by urban violence. It also is backing a set of research projectslooking at the situation of children under four. Consequently, it could contribute agreat deal to the design of future policies and government actions targeting thesepopulation segments.17

3.14 Indigenous peoples:18 Since 2002 the Bank has been assisting Chile in its pursuitof a public policy on indigenous peoples through a comprehensive indigenouscommunities development program (1311/OC-CH), better known as the ProgramaOrgenes. That initiative is seeking to improve living conditions and promotedevelopment with identity in the economic, social, cultural, and environmentaldomains in Aymara, Atacama, and Mapuche communities in rural parts of Chile.

3.15 IDB support to the current administration to implement phase II of the ProgramaOrgenes will build on lessons learned from phase I. The guiding approach will bethe sustainability of mechanisms to help indigenous communities work withprivate organizations and government agencies at the local, regional, and national

level. The envisaged focuses are indigenous community and governmentinstitution-strengthening, participatory planning, and investment support to bridgeopportunity gaps and strengthen indigenous peoples cultural identity. The Bankalso will help explore partnerships with the private sector to develop indigenousentrepreneurship, and could work with the country: (i) to create avenues andforums for dialogue and consensus-building on the recognition of individual andcollective rights of indigenous peoples, and (ii) for programs specifically targetedto urban indigenous people.

3.16 Older adults:19 The Bank-funded program of innovative interventions for olderadults (1574/OC-CH) has been assisting the government with capacity-

17 As discussed earlier, children under four are a particularly vulnerable group. According to the 2003CASEN survey findings, children under six have the highest poverty rate and make up a sizable shareof the total poor. Young children are the most strategic group from the perspective of closingopportunity gaps: investing in this age group will improve their future education outcomes and, whenthey reach adulthood, will see fewer of them living in poverty and improve the income distribution.

18 SeePueblos Indgenas: Desafos para el Desarrollo con Identidad, IDB Technical Note, 2006.19 SeeEnvejecimiento con Calidad de Vida, IDB Technical Note, 2006.
http://re1/roadmap/Docs/CHILE/Notas%20T%E9%A3%AEicas/Pueblos_indigenas_CD.pdfhttp://re1/roadmap/Docs/CHILE/Notas%20T%E9%A3%AEicas/Pueblos_indigenas_CD.pdfhttp://re1/roadmap/Docs/CHILE/Notas%20T%E9%A3%AEicas/Adulto_mayor_CD.pdfhttp://re1/roadmap/Docs/CHILE/Notas%20T%E9%A3%AEicas/Adulto_mayor_CD.pdfhttp://re1/roadmap/Docs/CHILE/Notas%20T%E9%A3%AEicas/Adulto_mayor_CD.pdfhttp://re1/roadmap/Docs/CHILE/Notas%20T%E9%A3%AEicas/Pueblos_indigenas_CD.pdf


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strengthening of the National Bureau for Older Adults (SENAMA) and innovativeventures to enhance government services delivery, build demand, and spur short-and long-term responses to improve the supply of, and access to, public and private

services for this population.

3.17 Drawing on its experience in that program, the Bank could continue working withChile to help: (i) increase the economic security of older adults through pension-system changes and create opportunities for nondiscriminatory access to paidemployment and business finance; (ii) prevent and reduce illness and disability,promoting and investing in initiatives dealing with the physical milieu, lifestyles,and preventive health care and rehabilitation services; (iii) increase the supply ofsocial services that enable people to age at home, creating supports for family andprofessional caregivers, and (iv) increase the civic engagement of older adults.

3.18 People with disabilities:20 The current administration will be managing a threefold

challenge: (i) address the absence of a structure of rights and operation of the cross-cutting principle in public policy regarding people with disabilities; (ii) fill multiplegaps in legislation, notably to deal with employment-related issues such aspositive discrimination measures, modify administrative-law health requirements,and give businesses incentives to hire persons with a disability; and (iii) removeaccess and transportation barriers for persons with disabilities (urban accessibility,housing policy with architectural accommodations, uniform standards), and developcapacity-building programs for disability-related nongovernmental organizations.To work with Chile on these issues the Bank could develop a pilot program ofcomprehensive support for persons with disabilities in selected municipalities.

3.19 Populations vulnerable to urban violence: An IDB study (2005) on publicsecurity management in Chile identified some of the challenges for the comingyears, among them: (i) too few and inadequate strategies and programs developedaround secondary preventive interventions (targeted to at-risk groups); and (ii) aweak institutional base and insufficient technical capacity in agencies with directresponsibility in this domain. To address the latter concern, President Bachelet haspledged to create a Ministry of Public Safety. The Bank, which is already assistingthe country through the A Safer Chile program, could help with that and otherinitiatives in this sphere.

2. Reducing competitiveness and income gaps with the developed economies

3.20 The World Economic Forums recently published (2005) 2005-2006 GlobalCompetitiveness Index rankings point up some of the factors that put Chile behindthe more advanced economies for competitiveness. These findings could inform

20 This section draws from papers by Cisternas (2005) and Cisternas and Tortuero (2005) produced as partof the IDB technical-cooperation operation for Chile dealing with persons with disabilities.
http://re1/roadmap/Docs/CHILE/Estudios/Informe%20sobre%20el%20estado%20de%20situacion%20politica%20chilena%20materia%20Discapacidad_%20Cisternas.pdfhttp://re1/roadmap/Docs/CHILE/Estudios/Informe%20sobre%20el%20estado%20de%20situacion%20politica%20chilena%20materia%20Discapacidad_%20Cisternas.pdf


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national pro-growth agenda priorities. Chile performed impressively onmacroeconomic management, where it was top-ranked among the countriesevaluated in the study, and earned scores comparable to the high-income OECD

countries

21

for such factors as market efficiency, health system coverage, andprimary education enrollment. But it trails that country-group average at a distancefor innovation (-27.5%), infrastructure (-20.9%), postsecondary education andtraining (-18%), technological readiness (-17.8%), and business sophistication(-13.2%).

3.21 The new administration aims to make Chile one of the 15 most competitiveeconomies in the world (2005 Bachelet administration agenda). The Bank couldassist in that effort through support for government proposals, strategies for public-private coordination and partnering, or private entities directly, in some keystrategic areas like the following, to make the nation more competitive and layfoundations for sustained productivity increases in the coming years.22

a. Innovation and technology development as key to productivity

increases

3.22 Prompted by recent studies that diagnose weaknesses in Chiles science,technology, and innovation sectors,23 the government has set a research anddevelopment (R&D) target for the nation: over the next five years, raise R&Dspending as a percentage of GDP from the current 0.7% level to over 1%. 24 TheMining Royalty Law passed by the Chilean Congress in 2005 created a specific taxon mining operations and established a public-private National Council onInnovation for Competitiveness, with a mandate to administer these additional

resources and a say in how public funds are budgeted for these purposes. Buildingon lessons found in implementing the technology development program(1286/OC-CH), the Banks support to Chile in this area in the coming years couldfocus on the following:

3.23 Develop an institutional base for innovation: Help create a technical support basefor the National Council on Innovation for Competitiveness, particularly to bettercoordinate Chiles national innovation system (NIS) and help it operate moreefficiently. Such support would focus on the Council and its technical bodies,aiming to turn it into the NIS articulating agent and promoter of policy

21 According to the World Bank, high-income OECD countries are economies with per capita grossnational income higher than US$10,066 in 2004 (Chile: US$5,390).

22 Following consultations with business representatives, union leaders, government officials and analyststhe Bank developed a proposal on the main private sector development focuses.

23 Including studies conducted as part of the technology development program (CH-0160) funded in partby the IDB and by other Chilean agencies, the World Bank, and the OECD.

24 On average, the OECD countries spend roughly 2.5% of GDP on R&D.


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coordination. It would track and evaluate NIS funds and institutions using acoordinated information system to monitor development instruments and theirimpact, consolidating current technology prospecting efforts, fostering sector

dialogue and analysis forums and arrangements, acting as catalyst to help shapepublic-private agendas, and leading a systematic diffusion effort.

3.24 Strengthen regional organizations and innovative clusters: The Bank is backinga program in Chile to set up and build capacity in regional development agencies, tostrengthen regional actors engaged in the areas of entrepreneurship, innovation, andscience and technology and thereby give them access to public funds, includingmining royalties. In the process the program will enhance the quality and efficiencyof subnational innovation agencies, spur regional strategy development in thesector, and help regional governments develop production in their respectiveterritories. As a further focus the Bank, working with the leading natural-resourcesclusters and clusters in other competitive sectors in Chile, could assist in the designand eventual implementation of a program to develop consensus-based strategies tomake such clusters more competitive, encouraging linkages and creation oftechnology companies that can deliver related products and services.

b. Support a new cycle of public-utility regulation reforms and

strengthen medium- and long-term energy security

3.25 Regulation. Many of Chiles public utility companies now are in private hands and,to judge from the evidence, privatization has worked (Fischer and Serra, 2005).Thanks to mounting investment in the different utility sectors, more of thepopulation now has access to a greater variety of better-quality services. Efficiency

improvements, showing up in sustained labor productivity increases, are a furthergain. Though private sector entry and regulatory reforms have enhanced publicutility services, there still is room for further regulatory strengthening especially inthe telecommunications and gas industries and for port services. The Bank couldprovide technical assistance to help Chile remedy regulatory weaknesses in sectorsin need of bolstering. The harmonization of gas sector regulations is anotherprospective support focus, under the IIRSA umbrella and, generally, throughregional integration agreements.

3.26 Energy security: Electricity demand is expected to rise 6% annually over the nextfew years, with slightly higher increases for natural gas. Since Argentina began

restricting natural gas exports to Chile in 2004 there have been service interruptionsin Chiles main power grids, creating uncertainty about medium-term power supplyand jeopardizing robust economic growth prospects for the coming years. In thishighly uncertain climate it would be well to explore a range of ways to lessen theserisks. That could mean a shift in the makeup of the countrys energy matrix,currently 37% crude oil, 24% natural gas, 18% hydroelectricity, 8% coal, and13% fuelwood and other.
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3.27 As a long-term response the Chilean authorities propose to seek alternative energysources, looking at: (i) a variety of domestic natural gas substitutes; (ii) incentivesto boost hydropower and nonconventional power generation; (iii) regionally based

alternatives, envisioning a regional energy ring in MERCOSUR; and(iv) liquefied natural gas imports transported by sea. The Bank could assist Chilewith technical analysis of the menu of options and funding to increase and diversifyenergy sources.

3.28 Chile also could slow the increase in power demand through more efficientenergy use, with a potential saving in the range of 1.5% to 1.9% annually, in themanufacturing, mining, services, transportation, and household sectorsparticularly. The country already has launched a national energy efficiencyprogram. Bringing to bear its experience in this area, the Bank could provideinput as Chile tackles the complex task of transforming the energy market, withthe attendant energy savings from the new dynamic created as more energy-efficient plant and equipment is adopted.

3.29 The Bank also could assist Chile in developing an electrification program to take inthe 8% of rural residents who are not connected to the grid. Because this is thecountrys most remote and scattered population, the program would have tocontemplate a variety of energy alternatives. The Bank currently is funding a ruralelectrification program in Chile (1475/OC-CH) aimed at increasing renewableenergy use, and has carried out similar projects in other countries.

c. Strengthen and develop the capital market

3.30 A number of flaws in Chiles capital market are constraining its potential demandand making it hard for medium-sized and large companies to obtain financing, andcould be a major roadblock for private enterprise to continue on its growth track(Gmez-Acebo and Ketterer, 2005). At the crux of the problem are certain stock-market infrastructure nodes that are not up to international standards. Consequently,there is weak demand for paper in the market, since: (i) global operators are all butabsent in the local government debt, variable income, and corporate debt markets,and (ii) other than in the pension fund manager and insurance company segments,domestic demand is very subdued.

3.31 The end-goal of the needed capital market reforms would be to increase

competition, specialization, efficiency, and security in the spot and derivativesmarkets, so new demand can attract new offerings and markets will be wider andmore liquid. The changes would have to be sufficient to: (i) enable the country totake a huge leap, situating its markets in a model equivalent to the one that hasallowed Europe to make its markets globally competitive, and (ii) enable companiesto secure a capital base that would position them to become true regional or evenglobal multinationals (Gmez-Acebo and Ketterer, 2005).


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3.32 To help bring in the sweeping changes Chiles capital market requires, the Bankcould support a comprehensive program encompassing: (i) technical studies todetermine changes needed in institutions and legislation to remedy the flaws

referred to above; (ii) investment loans and possibly sector loans; and (iii) peso-denominated debt issues by the IDB and by the private sector (via partialguarantees).

3.33 The Bank also could lend support in a number of specific areas to create innovativeinitiatives and financial solutions for some of the above-mentioned problems inChiles capital market, among them: (i) capital market access for medium-sizedenterprises, by clustering similar companies so they can borrow from institutionalinvestors; (ii) support for internationalization of large Chilean corporations, toreduce some of the specific operational risks associated with their inroads into othercountries in the region; (iii) development of loan securitization products in selectedareas (postsecondary education and hospitals); (iv) development of the carbon bondmarket, and (v) support for social housing finance vehicles.

d. Boost production capacity of micro, small, and medium-sized

enterprises (MSMEs)

3.34 Recent diagnostic assessments of MSMEs productive capacity indicate thatproductivity levels in these economic unitsparticularly microenterprises andsmall businessestrail those of larger companies. Furthermore, these smallerconcerns account for only a minimal share of export business and opportunitiesarising from free trade agreements. Tapping the experience it has built up in Chilein recent years with MSME-targeted innovative projects the Bank could help the

country tackle several of the foremost challenges, particularly through theInter-American Investment Corporation (IIC). The aim of such support would befivefold: (i) continue encouraging different-sized businesses to join forces toconduct interfirm transactions that add value to a given good or service destined fora specific market (industry clusters); (ii) on the financing side, support partialguarantees for the public sector and/or private financial institutions and, when apt,promote securitization of SME lending; (iii) reduce bureaucracy and streamlineadministrative procedures; (iv) help this segment of the economy do more to seizethe business opportunities created by free trade agreements; and (v) further thedecentralization and territorial coordination of MSME-related agencies andinstruments.


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e. Strengthen the external sector so it can continue to drive economic

growth25

3.35 Unfinished items on Chiles international trade and integration agenda are for themost part second-generation issues, principally: (i) increasing export variety andservice exports; (ii) deepening Chilean regions global trade inroads; (iii) continuedpursuit of the countrys multipronged trade strategy with an emphasis on exports ofservices; and (iv) transportation cost policies, particularly as regards intraregionaltrade.

3.36 There are three strategic sectors via which Chile could strengthen its external sectorto advance its economy, in which the IDBs experience in the country could provevery useful:

3.37 Promote agricultural development:26 Chiles agriculture-sector challenges in

years ahead consist in seizing emerging opportunities in Latin American and worldmarkets and moving into new lines such as meat (pork, lamb, and beef) and dairyproducts, olive oil, etc., and new markets like China, India, and Japan. Chileanexports are forecast to rise from US$7.5 billion today to some US$10 billion in2010 and close to US$14 billion in 2014. Small and medium-sized producersshould be part of this leap, as should regions that have the potential to contributesignificantly to agroexport development but have yet to do so.

3.38 The Bank can bring its experience to bear to help Chile achieve the above-mentioned goals through support for: (i) modernization of institutions, toconsolidate and diversify agrifood exports; (ii) irrigation and drainage, for the

design and financing of medium-scale irrigation works; (iii) livestock development,to help boost meat exports, working to improve productivity and marketing; qualitymanagement, and food safety, and to implement livestock product traceabilitysystems; and (iv) forestry development and biodiversity preservation, includingmanagement capacity building in sector institutions, forestry initiatives in medium-sized degraded areas, and native forest preservation in national parks and protectedareas. Other prospective support focuses are the development of forest-backedsecuritization schemes like the one launched by Fundacin Chile, and testing ofcontract logging systems.

3.39 Spur tourism sector development:27 In 2004 Chile took in close to US$1.396

billion in inbound tourism revenues, up 26% from 2003. This was almost on a parwith its salmon and trout export receipts and topped its wine export earnings(SERNATUR, 2005). Though the tourism industry has grown steadily in recent

25 SeeTrade and Integration, IDB Technical Note, 2006.26 SeeDesarrollo Agroalimentario:Desafos y Propuestas de Accin, IDB Technical Note, 2006.27 SeeFomento al Turismo, IDB Technical Note, 2006.
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years, a set of structural weaknesses are holding back its true potential to be one ofthe economys leading sectors.

3.40 Building on its extensive tourism-sector experience elsewhere in the region andwhat it has learned since 2004 in its first tourism development operation in Chile(1507/OC-CH), the Bank could work with the country in three priority areas tostrengthen it as a tourism destination: (i) innovative supply-side efforts, creatingnew tourism products and nurturing entrepreneurship around special-interesttourism; (ii) comprehensive destination management systems to bolster tourismsector institutions and encourage tourism development stakeholders to work inconcert; and (iii) making tourist businesses more competitive through qualitytechnology improvements, skills upgrading, and adaptation to environmentalquality technology innovations.

3.41 Strengthen environmental sustainability: Environmental preservation issues are

coming in for growing attention in Chile for two reasons: its people are demandinggreater care for nature, and its developed-world trading partners and the risingnumber of multilateral environmental accords it has signed on to are imposing moreand more stringent environmental protection requirements. The Bank could assistChile in several areas: (i) biodiversity and ecosystem inventorying, as soundunderpinnings for new policies; (ii) improving compliance monitoring, which willmean a review of institutional and budget dimensions, in the biodiversity areaparticularly; (iii) securing funding to continue programs that have operated well todate apart from certain noncompliance situations (ozone layer protection, forexample); and (iv) analysis and adoption of economic instruments to protectbiodiversity, as an adjunct to command and control instruments. This would call for

at least three work focuses: defining of property rights over the resources inquestion; incentive creation, and analysis of requirements in Chiles exportdestination markets.

3. Making government more efficient and bringing it closer to the citizenry

3.42 In the coming years the Bank proposes to frame its support for State reformprocesses in Chile around three elements. The first is assistance to the governmentin bolstering subnational governance capacity, with territorial developmentstrengthening as the guiding perspective. This process

Idb - Country Strategy With Chile

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