MAY 1991 - VOLUME 12 - NUMBER 5
P R I V A T I Z A T I O N & P L U N D E R
Chile's Privatization Experienceby Joseph Collins and John Lear
SANTIAGO, CHILE--Privatization has been a Washington policymakers' buzzword since the early 1980s. The message is unequivocal: be it in the Third World, the Soviet Union or the United States, private is good, public is bad. Perhaps no country has had a longer and more thorough dose of privatization than Chile. Backed by the iron-fisted dictatorship of General Augusto Pinochet (1973-1990), economic policymakers, schooled in the free-market philosophy of the University of Chicago's Milton Friedman, carried out sweeping privatizations. Between 1975 and 1989, these "Chicago Boys" sold government stakes in more than 160 corporations, 16 banks and over 3,600 agro-industrial plants, mines and real estate, not including the return of property expropriated during the previous government of Salvador Allende.
Today many governments, especially those unable to make payments on massive loans taken out in the 1970s, find themselves compelled to accept the economic policy overhaul prescribed by the World Bank and the International Monetary Fund. Privatization is a cornerstone of this "structural adjustment," and Chile is held up as a pioneering model. But the actual Chilean experience of privatization does not match the accolades it receives in the United States.
A strategy for development
Publicly owned companies came into being in Chile long before 1970, when Salvador Allende became the world's first freely elected socialist president. As in most of the rest of Latin America, the public sector in Chile had long played a crucial role in building infrastructure and providing the credit and protective tariffs necessary for the development of local industry.
In 1939, a populist coalition government created CORFO, the Corporation to Foment Production, a government agency that provided credit, conducted research and development and promoted numerous public enterprises and mixed private-public companies over the next three decades. CORFO selected projects for strategic reasons of national security or development and because the private sector was unwilling or unable to invest alone.
Over the years, governments of diverse political leanings took the lead in founding some of the industries which were to be among the most important to Chile's economic development. CAP (Pacific Steel Company) was formed by CORFO in 1946 as a mixed enterprise and became one of the most important steel producers in Latin America, generating useful linkages to mining and manufacturing industries. LANCHILE, the national airline, was formed in 1931 as a project of the military. ENDESA, the national electric company, and several other regional electric companies were formed to ensure the supply of electricity to provincial areas where private companies were unwilling to invest.
The Popular Unity government of Allende (1970-1973) in its initial program contemplated only a limited number of expropriations of private companies thought essential to placing the state "at the strategic heights of the economy." Allende and his advisers hoped that the government could thereby redirect the economy in order to break patterns of uneven development they believed due to exploitation by foreign companies, feudalistic structures in the countryside and a backward oligopolistic industrial sector. One of Allende's first pieces of legislation, unanimously enacted by Chile's congress, nationalized the foreign-owned copper industries, creating the giant public company CODELCO.
Before long, however, production sabotage by some owners antagonistic to the government and factory takeovers by workers and political activists spurred the Allende administration to take control of many more enterprises than officials had originally envisioned--certainly more than made economic and management sense. By the September 1973 military coup, the public sector formally included the country's 19 banks and 185 other companies and, de facto, an additional 350 "intervened" firms.
The Chicago Boys
Privatization of public holdings was high on the agenda of the Chicago Boys whom Pinochet brought to power. Their first step was to return the property expropriated during the Allende government (with the exception of the public copper company), a process that was completed by 1975 and that left the traditional public sector intact.
Subsequently, the Chicago Boys put Chile's traditional public sector through two waves of privatization, the first from 1975 to 1981, the second from 1985 until Pinochet surrendered political power in 1990. The first wave of sales was made up primarily of the banks which had traditionally belonged to the public sector. In most cases, an entire bank went to a single purchaser from the handful of families which had dominated Chile's finance and industry during the previous half century.
The Chicago road to socialism?
With the financial collapse and recession beginning in 1981, free-market ideologues ran into a major stumbling block on their road to privatizing the Chilean economy. Indeed, much of what they had wrought up until then was virtually undone.
Massive losses by the most important Chilean banks (and the industries owned or indebted to them) forced the Pinochet government to come to their rescue rather than simply letting them fail, as prescribed by freemarket doctrine. The government, at the urging of the IMF and World Bank as well as Chile's other major international creditors, took over the failed banks and businesses, in the process making the government and the Chilean public responsible for $4.7-billion in foreign loans contracted by private Chilean institutions. Of the 19 banks that the government had privatized in the 1970s, all but five failed and fell back into government hands, as did 90 other diverse bankrupt enterprises. The government-controlled portion of the economy in 1983 rivalled that of the final year of the Allende government. The irony was not lost on free-market critics, who mockingly referred to this phenomenon as the "Chicago road to socialism." The government eventually resuscitated the enterprises it took over and resold them to the private sector by 1985.
The irony was heightened by the fact that the one bank that had not been privatized and other public companies survived the crisis in relatively good shape. Their profits and taxes remained important sources of revenue for the financially strapped government, which needed money to sustain its expensive program of resuscitating the failed privatized banks and companies.
The success of the public sector businesses was largely due to a tradition of competence and efficiency among Chilean public industries that was in stark contrast to the recent (and historic) tendency of the private sector towards speculation and short-term profit-taking over investment. The balance sheets of the publicly owned companies had also been improved by many of the recent "rationalizations" within the public sector (by which workers were dismissed, wages reduced and prices for goods and services raised). When Pinochet's Chicago Boys caught a second wind and announced a second and even more sweeping wave of privatizations, virtually every major public enterprise was turning a profit, generating 25 percent of the government's total revenues.
The second wave of privatization began in late 1985, when the government announced plans to privatize most of the remaining large public companies, which still included six of the ten largest corporations in Chile. Many in the Pinochet government, in particular the U.S.-trained technocrats, were uncertain about the outcome of the impending 1988 plebiscite on Pinochet's continued presidency. They therefore redoubled efforts to complete their agenda to transfer assets and financial authority from the public to the private sector. During the year that followed Pinochet's defeat in the 1988 plebiscite and leading up to the defeat of his candidate in the resulting December 1989 presidential election, the Chicago Boys continued to privatize, touching public companies once thought sacred, such as the national airline LANCHILE and the long-distance telephone company. Only in the case of the public copper company CODELCO did the military government decide to follow self-interest over ideology, allowing the successful business to continue to operate in the public sector undisturbed. Constitutional law provides that 10 percent of total CODELCO gross revenues go to the military as a no-questions-asked supplement to its budget.
The price is right?
Many Chileans describe the minimal prices at which public holdings were sold as scandalous. To make the deals even sweeter, the government often financed the sales, allowing the buyer to use stocks and the company to be purchased as collateral.
One of the most notorious abuses occurred with the sale of the steel company CAP, Chile's most important manufacturing corporation and third-largest public company. The estimated value of CAP was $700 million in late 1985, when the initial package of the company's stock went on the market at rock-bottom prices in the wake of the recession. Then, in 1987, CAP negotiated with the government agency CORFO to buy back and retire almost half of its stock still in the public sector in exchange for $72 million in CAP's working capital. This operation was of dubious legitimacy; since CORFO held 83.2 percent of CAPs stock, when CAP bought its stock from CORFO, it did so with what was mostly CORFO's money. It was certainly a windfall for the private stockholders, whose combined share in the company immediately tripled to 49 percent. One happy shareholder was the CAP director and now CAP president who bought up shares for himself and family members during the month in which negotiations with CORFO were underway. (He later defended his actions by arguing that he was merely demonstrating confidence in the corporation he ran.) The company's profits in the next two years, all paid out in dividends rather than ploughed back into investments, earned back all of the initial investors' investment.
Mario Marcel, an economist for the Christian Democratic think tank CIEPLAN, calculated that the 12 companies privatized during 1986 and 1987 were sold with an effective subsidy from the national treasury to the buyer of 27 to 69 percent, depending on which of various recognized ways of determining value was used. The economists Gustavo Marin and Patricio Rozas estimate the national treasury lost $1.4 billion from the sale of three of the largest companies in the late 1980s (CAP, Chilectra and Soquimich).
Audits of CORFO privatizations done by a separate government accounting office are damning. IANSA, the sugar refining company, was sold for $34 million, though its book value was $81 million. IANSA profits for the years 1986 to 1988 alone were $52 million, far exceeding the purchase price. Soquimich, the nitrate and fertilizer company, was sold for $120 million, an amount which, given the dividend levels of 1988, investors would recuperate in less than three years. In the case of ENDESA, the huge electric company whose privatization was completed after the plebiscite, internal auditors of CORFO estimated a total loss of almost $1 billion. An official in CORFO conservatively estimates that losses to the national treasury resulting from undervalued sales and lost earnings during the years 1985 to 1989 surpassed $2 billion--in an economy whose GNP in 1987 was less than $20 billion.
Privatization scandals abound. With no free press, no public discussion of policies and frequent changes in whatever goals and procedures the government did announce, it was easy for insiders to maneuver in their own interests as well as those of family members and friends. Commonly, the administrator of the privatization of a public holding wound up occupying the top post in the privatized company. Julio Ponce Lerou, Pinochet's son-in-law, was director of Soquimich and emerged as president of the privatized nitrate company in 1987, with several of his relatives sitting on the board or having become major stockholders. Notorious Pinochet labor minister Jose Pinera became the vice-president of ENDESA, the privatized national electric company. When Pinochet surrendered the presidential sash in March 1991, many key figures from his long dictatorship were firmly ensconced at the top of Chile's privatized banks and manufacturing and service companies, creating a de facto continuity in positions of power for some of the regime's most ideologically extreme defenders.
A quick fix
Revenues from sales of public corporations provided one-time boosts to the government budget, allowing Pinochet the luxury of balancing the budget from 1986 through 1988, pleasing the IMF, making timely payments to foreign creditor banks and even cutting taxes. However, since the companies sold had produced revenues for the government rather than deficits, such gains were brief and illusory. Future governments will bear the loss of those income generating assets. Estimates for lost revenues range from $125 to $200 million annually for the years 1990 to 1996. The higher estimate equals the total new social spending the government hopes to marshal for 1991.
The myth of "popular capitalism"
Proponents proclaimed Chile's second wave of privatization the road to "popular capitalism," since employees in many of the companies undergoing privatization could opt to purchase shares by drawing from their workers' compensation fund. But employees' holdings are a distinct minority of every privatized company's total shares, and management-level employees were those most able to take advantage of the stock offers. Only in a single case have workers managed to gain a seat on the board of directors.
Labor has not benefited from the privatizations. As prerequisites to the privatization process, the Chicago Boys abolished virtually all labor rights through the 1980 Labor Code and eliminated the power of union leaders in numerous public companies. Those union leaders who publicly opposed privatization often met with intimidation and firings. In some cases, they were bribed.
Early in the second wave of privatization, union leaders from public companies met to organize the Commando for the Defense of Public Enterprises, which conducted an arduous campaign against the privatizations. Confronted with brutal government repression during the mid-1980s, the organization was rarely able to mobilize people outside the unions and proved largely unsuccessful. Opposition politicians, intellectuals and even some former government officials set up a parallel organization, the Committee for the Defense of the National Patrimony. Raul Saez, the committee's head, had been a key official involved in the formation of many of CORFO's companies in the 1950s and 1960s and was briefly Pinochet's Minister of Finance. "God will not pardon the tide of privatizations," he declared to the national press during the post-plebiscite flurry of privatizations.
When the privatization wave rolled on after the plebiscite, presidential candidate Patricio Aylwin threatened to undo the last-minute privatizations of the outgoing regime. Now, however, a year into its term, the Aylwin administration has not reversed or even called into question a single sale.
With the Pinochet privatization agenda largely completed, strong vested interests have emerged to defend its "accomplishments." In the case of one public firm, ENDESA, stock was made available for purchase to public servants outside the company on similar terms as to ENDESA employees. By far, the largest percentage of stock (about 21 percent) was made available to members of the armed forces, who now form a rearguard of property owners which firmly opposes any efforts to bring such companies back into the public domain.
The new multinational order
Multinational corporations have gained a stronghold over the Chilean economy through their control of financial companies that control workers' pension funds. These competing, private pension fund companies were set up in 1980 as a mandatory replacement for the government social security system. After the crash of 1981-1983, several of the most important pension fund companies were taken over by the government.
When they were resold in the following years, foreign financial consortia purchased controlling shares in many. For example, a Bankers' Trust holding group (which includes three other international creditor banks that hold Chilean debt) has a controlling interest in the largest pension fund. Aetna controls 51 percent of the next largest fund and the American International Group owns another. The three groups together now control 55 percent of Chile's private pension funds. In turn, by 1989, the pension funds had acquired an average of 32 percent of the stock of the privatized companies.
Pinochet's Chicago Boys claim they have fostered "popular capitalism" by making some 3 million Chileans part-owners of the privatized corporations through their pension funds. But Chileans who pay into their pension funds do not actually own stock in the pension fund companies and therefore have no say in how their funds are invested. Bankers' Trust and other financial groups have that power and can use it to look out for their own interests.
These same multinationals have also made direct investments in a number of privatized companies. Bankers' Trust now has investments in 13 companies, including the steel company CAP, the nitrate company Soquimich and several regional electric companies, all recently privatized. Aetna has important investments in six privatized companies.
Privatizations combined with debt swaps have become prime mechanisms for multinationals to increase their holdings in Chile. Debt swaps, by which international debt paper is bought at a discount (generally around 30 percent below face value in the case of Chile) and spent at near full face value in local currency within the debtor country, became an irresistible way for inter-national banks to cut their losses on loans that were unlikely to be paid back and to gain access to some of the most lucrative assets within debtor countries. Chile has been the pioneer of the debt swap in Latin America, with over $4 billion of its $21 billion foreign debt swapped for assets, much of it in companies once publicly owned. The discount given on the debt paper combined with the undervalued price of the privatizing corporations creates a double subsidy to foreign capital.
By mid-1988, 13 of the 19 completely privatized companies were controlled directly or indirectly by multinational corporations. Beginning in 1992, foreign companies will be allowed to take their profits out of Chile, possibly cancelling any advantage in external accounts gained by reducing the debt. Saez of the Commando for the Defense of Public Enterprises questions whether "the new owners, national and foreign, [will] be willing to forgo dividends in order to build new steel factories or new electrical generators." This has been the historic role of the public sector because of private sector unwillingness.
An official who has observed three decades of changing public and private sector roles from within CORFO complains that the Pinochet government simply handed over natural monopolies like electricity and telephones to the private sector and foreign capital without establishing any regulating power or any other significant counterweight. "These new financial groups are as powerful as the drug lords in Colombia, powerful enough to bring down any government" which might attempt to regulate them, he says. Privatization has made multinational companies in Chile more powerful today than ever before.
The balance sheet for Chile's privatization experience is very different than its advocates tout. Proponents argue that privatizations eliminated an inefficient and politicized public sector, reduced government fiscal problems and helped to disperse ownership. In fact, most of the companies privatized were producing significant profits, not deficits, for the government. Control went to a limited number of domestic and foreign interests that captured most of the subsidy implicit in the low prices. Revenues from sales provided a one-time financing of the budget deficit in exchange for a medium-term future of severe fiscal constraints. The government has been stripped of most of its potential to shape a truly competitive economy which serves the interests of the majority of Chileans. This is the legacy left by General Pinochet and his Chicago Boys.
Joseph Collins, the co-founder of the Institute for Food and Development Policy, and John Lear, a Latin American historian, are authors of the forthcoming The Chile Model: Miracle or Mirage? Free Market Economics on Trial.