The Fallacy and Failure of Neo-Liberalism:  Any Lessons from

the “Chilean Miracle”?


by Tesfaye Habisso, July 18, 2010



Historically, development economics offered several theories to developing economies in the 1950s and 1960s the application of which was intended to enable them to overcome the problems of low growth and high poverty. Briefly, prominent among them were the theories of development advanced by ‘the so-called pioneers of development economics,” such as Clark (1957), Hirschman (1959), Lewis(1956), Nurkse (1953), Myrdal (1968), Prebisch (1969), R. Rodan (1964), Lebenstein (1963), Rostow (1960), Singer (1966), and Tinbergen (1958).


Though these theories differed considerably within themselves, there were certain unmistakable commonalities: they all recommended an inward looking development path with a leading governmental role in the growth process. As regards the industrial sector, they recommended an import substitution based industrialization (ISI) policy that encouraged the promotion of production of goods that substituted for imports, control of imports from outside and relative neglect of exports. However, the overall outcomes of these strategies were not encouraging in the sense that these developing economies which pursued this path did not experience a consistent high growth or drastic reduction in their poverty levels. These theories were therefore challenged in the 1970s and 1980s by what is now called the counter-revolution in development economics.


The major attack of the counter-revolution was on the key role of the government in development and on the neglect of the market which was seen as an efficient allocator of resources at the macro level and minimize of production costs at the micro level. The counter-revolution viewed government as ineffective in achieving objectives, counter-productive with undesirable side effects and excessively costly as well as a breeding place for immense corruption. In other words, on the one hand, the government failed to deliver the goods particularly in trade and industry, while, on the other hand, the neglect of the market forces led to the neglect of competition with implications for efficiency and incentives.


The supporters of the counter-revolution therefore predicted the collapse of the earlier generation of theories and victory for the neo-liberal paradigm. The latter paradigm views the state as “bungling, blundering and botching” and the market as an efficient allocator of resources, provider of incentives and a vehicle of growth [Srinivasan 1994, Auroi 1995, Singh 1994, Smith 1995, World Bank 1991, Amdsen 1989, Hill 1996]. The role of the state under the new paradigm therefore has to be mainly market friendly—to facilitate the functioning of the markets. That is, the state is expected to manage a stable macro framework, ensure competitive markets, invest in human capital and arrange safety nets for the poor and the weak. Vigorous competition in free markets is expected to be the key to prevent the concentration and abuse of economic power [Srinivasan 1994]. In the field of industry policy the new development paradigm recommends the promotion of export-led industrialization [ELI] in the place of import substitution based industrialization [ISI]. That is, instead of putting trade barriers to protect domestic import substituting industries, it recommends the promotion of export-based industries that would lead to competitive efficiency in the exporting industries, on the one hand, and the pattern of industrialization based on comparative advantages of the country, on the other hand. This is the paradigm which is accepted and recommended for the world economy and for national economies as a solution to the ills of both the developed as well as the developing economies. This paper is aimed at unraveling the essentials of neo-liberalism as an ideology and its dismal failure in bringing development in the developing economies. It will also briefly deal with the so-called “Chilean Miracle”, a test-bed case for the fallacy of neo-liberalism in its application on a developing economy. A brief backgrounder will also be given on what went wrong with the ideology and on what works for developing economies in the Third World, its implications and  raison d’etre for the ascendancy of the developmental state in late industrializing countries of the Third World, in South East Asia, Latin America and Africa. The need for the latter countries to move towards a developmental state as well as the lessons of the “East Asian Miracle” will be, hopefully, dealt with in subsequent weeks.


"Neo-liberalism": Clarifying the Essentials - What Is It? What Does It Mean?

 The term stems from the original "liberal" economics of Adam Smith, who published his "Wealth of Nations" in 1776, the same year that the American revolution began in earnest. In that seminal classic, the first to really adequately describe the functioning of market economics, Smith argued that markets work best when there is minimal interference from government, and that neither government, nor market players with any significant share of power, should be allowed to interfere with the "unseen hand" of the free market. What "neoliberals" do not understand, and very few are aware of, is the fact that Adam Smith mentioned limited liability corporations only twelve times in "Wealth of Nations," and each time, he made it clear that his views did not favor them. In fact, he viewed transnational corporations (such as the East India Company, one of the largest trans-nationals of his day) with considerable mistrust and even alarm. He'd seen their behavior in India and the American colonies, and wanted no part of those abuses which had played no small part in bringing about the American revolution itself, through the tax concessions it had won from the British crown at the ruinous expense of American colonial competitors. Smith felt, as did most of his contemporaries, that markets function only when populated by large numbers of small, preferably local players, who are kept free of the restraining influence of powerful corporations, monopolies and excessive governmental intrusion.

The Founding Fathers of the American revolution had seen the abuses of the East India Company, and shared that mistrust. Laws were enacted throughout the colonies that limited what corporations could do, what size they could achieve, and how they could behave in the market, and most importantly, for how long they would remain enfranchised. Yet the money made by corporations supplying the war effort in the Civil War gave them the money and power they needed to get those laws changed. The first to succeed in doing so was the Union Pacific Railroad, in 1867. Chartered for the purpose of building half of a transcontinental railroad, it was also the first to use bribery, influence peddling, stock "watering," laying shoddy track only to qualify for the subsidies for which it qualified, and a host of other corporate abuses, still seen today. But its power had grown to the point where the abuses were largely unstoppable, largely as the result of misinterpretation of the U.S. Supreme Court decision in Santa Clara County vs. Southern Pacific, in which it was incorrectly assumed that the Supreme Court granted corporations the rights of "natural" persons. Other entrepreneurs, seeing the UPRR's success, and Southern Pacific's new legal rights, emulated them both with a series of other large limited liability corporations, and by the end of the 19th Century, those entrepreneurs had become known as the Robber Barons. Wealth became so concentrated in such few hands that it hobbled the economic growth of the nation in what became known as the Robber Baron Era, or The Guilded Age.

By the Great Depression of the 1930's, it had become apparent that unrestrained free markets had some serious flaws. First, the unrestrained accumulation of wealth brought with it the unrestrained accumulation of power - railroads were, for example, literally buying and selling corrupt state legislatures and U.S. senators among themselves as if they were commodities. The abuses of the Robber Baron Era had brought with it a replay of the abuses of the East India Company a century earlier and created in the popular mind an understanding of the need to rein in the power that the unrestrained concentration of wealth could bring. Second, it had become obvious that there were certain functions that simply worked better when government ran them; road networks were the first, as it was obviously impractical to have to pay tolls to every property owner along a thousand miles of road. Second was the postal system. Chaos would rein if one had to buy a stamp for every private mail operator a letter might have to be handled by, so a single, unified postal system made a lot of sense. Water supplies and sewage and garbage collection were other examples. In a later era, electric power and telephone utilities would also arise as problematical, when streets were being rendered constantly impassible by continuous construction being done by one utility company after another. Some streets were left dark at noon by the forest of telephone wires from different, competing companies on overhead cables and wires.

Additionally, it became apparent that if private banks were allowed to freely control the money supply without any restraint, that a continuous cycle of boom and bust, caused by monetary inflation and contraction were inevitable. These business cycles had wreaked havoc and had caused much misery throughout the 19th century, and into the 20th, leading to the overwhelming misery of the Great Depression. What to do about it?

Into that gap of understanding stepped John Maynard Keynes. Keynes explained that government had a legitimate role in economic management, and in the regulation of "natural monopolies," whether by direct ownership or by tight regulation of private ownership. By engaging in deficit spending during contractions, and running budget surpluses during inflation, business cycles could be reined in and the misery of business panics could be avoided. Further, he argued among other things that business cycles had the effect of transferring vast sums of wealth from the poor to the rich, as a result of the fact that the poor had few means of defending themselves from the effects of a business panic or a monetary inflation, and the rich not only could defend themselves, but could even exploit the business cycle. This is why unregulated markets always created societies with a tiny, rich elite and a vast, dispossessed lower class.

Keynes' ideas became known as "Keynesian economics." They became the cornerstone of Franklin D. Roosevelt's policies in dealing with the effects of the Great Depression. Roosevelt could see that the Crash of '29 had transferred truly vast amounts of wealth from the poor to the rich, leaving a whole nation impoverished, and so he sought to tax that wealth and allow access to it by means of government make-work policies. The idea was to not only create a middle class, but transfer most of the poor into it my providing them the opportunities to uplift their circumstances. In doing so, he earned the undying enmity of the wealthy, whose money he was taxing to pay for it. They sought their revenge. They got it by the "invention" of "neo-liberalism."

"Neo-liberalism" is not based on Adam Smith, as is often claimed for it by the libertarian propaganda, but is, in reality, based largely on the ideas of an Austrian economist, Friedrick Hayek, who had written in the 1930's that the control of an economy by a government is the "road to serfdom," as he titled his treatise. Asserting that human rights sprang from property rights, he claimed that a society could be no more free than its economy. The two principal failures of his analysis, were of course, first, the premise that human rights are a function of property rights, and that a society that planned its economy was doomed to serfdom. What Hayek never considered is that the obverse of such a policy is obviously that someone who has no property, has no rights, which means that person is, quite obviously, vulnerable to the very serfdom that Hayek claimed to fear. Witness the millions in debt-slavery in India and much of the rest of the world - the very serfdom that Hayek claimed to be repulsed by. The second major error was the assumption that corporations were entitled to the same property rights as individuals, and yet somehow deserved an exemption from liability that individuals do not enjoy - a basic inequality of rights. But nevertheless, his ideas had a great deal of resonance among social libertarians, who were highly enamored of an economic theory that corresponded to their social theories. It also found additional resonance in the writings of the Russian philosopher and popular novelist, Ayn Rand, and became the basis of her philosophical celebration of what can only charitably be described as selfishness.

The conservatives of the Republican Party in the U.S. in the 1960's and 1970's used that period of slow economic growth as a means of persuading policymakers that Keynesian economics had somehow failed, and that only a turn to the deregulation advocated by Hayek could solve the problems of "stagflation" that had become such an intractable problem. So, claiming that Keynes was dead, "neoliberal economics" was born, brought to life in America by a bald, mousy-looking economist from the University of Chicago, by the name of Milton Friedman. Friedman knew that Hayek's ideas were functionally anti-egalitarian, regardless of the title of his most famous book, yet Friedman privately, but freely admitted that he was not an egalitarian and didn't care about fairness. This made him the instant darling of the "neo-liberals."

Friedman was the undying, sworn enemy of Keynesian economics. He widely publicized what he considered to be a need to return to the "unseen hand" of the market to cure the "stagflation" of the time. His ideas were exactly what the right-wing rich elites needed in an economic theory. It was simple, easy to understand, superficially reasonable and logical, and above all else, suited their need for an economic theory, which, if implemented, would enable them to accumulate wealth and thereby transfer its accompanying power to themselves without restraint. It suited their desire for revenge and their greed and avarice beautifully. Friedman very quickly became their darling, lavishly gifted, and being driven around the University of Chicago campus in a chauffered limousine. Paul Samuelson, Friedman's long-time rival and the principal advocate of careful, sensible regulation of business and government intervention in the market in the Keynesian mold, tirelessly warned of the anti-egalitarian dangers of Friedman's approach, but amidst the propaganda, he was largely forgotten, even though it was his ideas that had not only prevented a return to business cycles, but had created a vast middle class in America in just a couple of decades following world war II. And ultimately, it was Samuelson's ideas which in the end saved the Chilean economy.

The "Neo-liberal" Chilean Miracle

The "neoliberals" needed a test-bed to "prove" their ideology and refine their repressive methods. And since Chile had just been handed to an American stooge, Augusto Pinochet, he was recruited to try them out and see how well they worked. The idea wasn't really to actually test them, as much as it was to create the illusion that they worked, whether they actually did or not, so they could be sold everywhere else in the world under a variety of labels: "neo-liberalism," "free-market economics," "libertarian economics" and "the Washington Consensus." Most objective economists knew quite well from the beginning that they wouldn't work in the long run and many said so publicly, but were quickly shouted down in the intellectual coup-de-etat of the Ronald Reagan years.

There were five cardinal points of "neoliberal" agenda that were and are to be implemented wherever it was or is to be implemented, beginning in Chile. They include:

·         The supremacy of the free market. The market was to rule supreme, unrestrained by the intervention of government, labor unions, or anything else (other than corporate monopoly power) that constrained the operation of market forces, regardless of how much social disorder, suffering or exploitation results. Any undesirable effects are to be ascribed simply to "unidentified interventions" which, when they were identified, could be eliminated, and the problem solved thereby. Monopolies were simply assumed, against all evidence, to be self-limiting (though no one ever managed to explain how DeBeers Consolidated Mines had managed to create and maintain a worldwide monopoly on the diamond business for more than a century).

·         Cutting, and eliminating when possible, expenditure for social services. Again, in the name of reducing government interference in the market, it was not necessary for government to involve itself in social welfare programs. To explain the obvious suffering that results, it is therefore claimed that when the poor suffer, it is due to their own laziness that they do not better themselves. That the accumulation of money was equivalent to the accumulation of power, with its attendant distortion of the functioning of the market, was not a concern. That this led inevitably to the disempowerment of the poor was not a concern - the poor were blamed for their condition by claiming their "inferiority" or "bad decisions." Social justice was a non-issue.

·         Deregulation. If government is interfering in the market, it will only lead to a loss of profits, and therefore, government regulation had to be assumed to be bad. Therefore, it has to be reduced or eliminated, even in monopolistic situations. One neo-liberal, Grover Norquist, an official in the George W. Bush administration commented that he wanted to reduce the size of government to the point where he "could drown it in the bathtub" - and then go on to do so.

·         Privatization. Since government is assumed, as a given, to be inefficient, lazy, bloated and uneconomical in the provisioning of goods and services, it was only reasonable to presume that private enterprise could and would perform the delivery of services in a more efficient manner, and hence any activity that delivers goods or services to citizens should and must be privatized. Never was an explanation offered for the contrary incentive of capitalism - that the capitalist's basic profit-driven incentive is to charge as much money as possible for providing as few goods and services as possible.

·         Elimination of the concept of "Community" or the "Common Good." Since this is antithetical to the notion of privatization and "rugged individualism," the concept of the commons (the air we must all breathe, the water we must all drink, etc.) to them, reeks faintly of Communism, it is assumed to be bad, wrong, and hence is oppositional to the "neoliberal" agenda. Such notions as public health, public education, etc., are to be replaced by private initiative, as anything else is simply considered to be a manifestation of lassitude, indolence and governmental dependence.

Pinochet allowed Milton Friedman and his cronies, principally Arnold Harberger, along with a small clique of Chilean "neoliberal" economists to implement this "neoliberal" agenda. Here was Friedman's chance to prove himself right and Samuelson wrong. Friedman was given a more-or-less free hand to implement whatever economic reforms he deemed needed, and Friedman did so with a vengeance. In a quick succession of reforms, the collective-bargaining law was abolished, essentially eliminating the influence of labor unions. The minimum wage law was abolished. The Social Security System was privatized, by being evenly divided among six companies, each to compete with each other. Public assets were sold, often at bargain basement prices, to whoever would buy them.

On the political side, Pinochet did his part by rounding up any opponents of the "neo-liberal" agenda. Anyone who questioned the wisdom of the reforms being implemented by the "Chicago Boys" was swiftly rounded up and, as often as not, never heard from again. Trade union organizers, economic justice advocates, Leftists and anyone else who objected to the reforms began to disappear. By the end of his regime, Pinochet was responsible for the deaths of at least 3,000 people and the disappearance of many thousands more.

Gradually eliminating their political competition within the military and civilian bureaucracy, the Chicago Boys had, by 1975, accumulated enough political capital to implement their program pretty much as they pleased. They began a series of far-reaching reforms - which they called "shock treatment" - which included devaluing and floating the currency, steeply increasing interest rates and slashing tariffs to counteract the inflation that the devaluation would have caused, while greatly reducing public expenditures. They abolished all taxes on wealth and business profits, and began slashing government workforces, including selling off any and all state-owned enterprises.

Social reforms included school choice, labor law reform, social welfare reform, and many other similar proposals that would be instantly familiar to current American conservatives as part of their own agenda. The effects, however, were exactly what American social liberals had predicted - a generalized increase in poverty, disease, homelessness, and a general spread of squalor, unrest and disaffection - all effects that were of no concern whatever to the Chicago Boys.

The land reforms carried out by the two previous administrations, including Allende's, were also reversed. But the reversals were not to restore the land to its previous owners, but rather to consolidate ownership of it for the use of export-oriented corporations. The slogan was "the three 'F's,' fruit, forest products and fish." Never mind that those whose land had been expropriated were not compensated or offered other means of employment. They were left to fend for themselves, swelling the ranks of the already previously dispossessed, former members of the working class who had worked, often for years, in the newly-abandoned factories, and were left with nothing.

The Chicago Boys began privatizing anything and everything in sight - 212 state-owned enterprises in all, including utilities - resulting in steep rises in utility costs, transportation costs and health care costs for ordinary Chileans. The banks were an especially interesting case. The Chicago Boys convinced Pinochet that freeing the banks from government regulation would attract foreign investment, and competition would enforce fiscal discipline and honest accounting. So in a case of deregulation gone berserk, the general sold off all six state-owned banks to the first comers. They quickly fell into the hands of two speculators, Javier Vial and Manuel Cruzsat. These two then promptly used the banks as collateral on loans obtained from foreign sources to buy up local industrial enterprises. Disposing off these enterprises to foreign companies generated more cash, which Vial and Cruzsat then used for even more leveraged buyouts, and as the end approached, these go-getters got themselves gone. It was a classic Ponzi scheme. Soon, Chileans faced the problem of having no trustworthy banks at all through which they could conduct banking transactions.

Freed from the heavy hand of bureaucracy, business regulation, taxes and public-owned enterprise, the economy took off - right off a cliff and into a severe recession. The slowdown had the predictable effect on Chile's industrial sector, resulting in massive layoffs and reduced economic activity. Suddenly, Chile's large and prosperous middle class found itself facing huge unemployment increases, rapidly falling salaries and rapidly increasing living costs.

The economic performance of the Chilean economy after the application of the "shock treatments" was anything but impressive. While there were three short bursts of impressive economic growth (which were impressive mostly because they were really just periods of recovery), they were interspersed with the classic steep, sharp, much lengthier contractions, which simply added to the growing misery of the poor and the former middle class. The later recessions, the last of which synchronized with world-wide recessions, were exacerbated by the liberalization of trade policies, making it more difficult for local industries to compete, either locally or internationally. Add to that the banking collapse caused by the privatization of the banking system, created widespread problems with credit, especially for the poor, and the stage was set for economic failure. Blood and glass began to litter factory floors throughout the country. Real economic output declined by a full 19% in 1982 and 1983 alone. The Chicago Boys, in classic Orwellian doublespeak, declared the results a terrific success, in spite of the remarkably poor metrics. The U.S. State Department seemed to agree, declaring "Chile is a casebook study in sound economic management." Ronald Reagan's propaganda machine was also highly supportive. Almost no one questioned it when Art Laffer, a Reagan protege and colleague of Milton Friedman, coined the phrase, "The Chilean Miracle," and stated that Chile is "a showcase of what supply-side economics can do" [Palast].  It certainly was for those who bothered to look.

Back in the streets of Chile, things hadn't been a miracle, they'd been a disaster. It was the results of the privatization of the banks that proved to be the last straw for the Chilean people. By 1982 the pyramid scheme being run by Vial and Cruzsat had collapsed, leading to the foreclosure of the banks and the complete loss of the meager savings of millions of Chileans, and surplus labor led to their inability to live day to day on their rapidly falling salaries. Riots and demonstrations by people so desperate they no longer feared bullets forced Pinochet to reconsider the Chicago Boys and their failed economic policies which had simply been re-creating the boom-bust cycle that had caused the hated Keynes to formulate his theories of government intervention in the first place five decades earlier. Pinochet demanded and got the resignation of his economics minister, Sergio de Castro. It was a sign that the Chicago Boys had fallen from grace. The dictatorship quickly moved to re-nationalize the banks to keep them afloat and prevent a liquidity crisis and economic downturn from turning into a complete wholesale economic collapse. He moved swiftly to re-impose some of those policies most hated by his supporters - a minimum wage law, a restoration of colllective bargaining rights and a jobs-creation program to create 500,000 new jobs. The newly privatized pension schemes were also being run like pyramid schemes, and were on the brink of collapse. To save them, he imposed stringent new regulations concerning their operations. To save the economy, Pinochet embarked on a nationalization scheme that would have left even Allende breathless - he expropriated at will, offering little if any compensation for what he nationalized. Much of what he appropriated would eventually be slowly re-privatized, much more carefully this time, but the very symbol of Chile and the mainstay of its foreign exchange earnings - the copper industry - would remain in state hands. Going even further, Pinochet instituted a law - still in force - that gives the military 10% of the revenues from the copper production. All this caused Pinochet's critics to quip that he'd embarked on "the Chicago Road to Socialism." The Chicago Boys were summarily dumped on a plane to Chicago - and told they weren't going to be welcomed back anytime soon.

But Pinochet's new economic team still included the Chilean "neoliberals," however. They continued to push for the "neoliberal" agenda, mostly as a result of the fact that the generals were in power in Chile because the Reagan administration in Washington wanted them to be, and because Reagan was a "neoliberal" himself and insisted on these policies. So those that caused only mild discomfort, if not the ones causing huge disruptions, remained in place. To this day, Santiagoans ride city buses run by private companies, and put up with delays, bad service, disruptions and dirty equipment, rather than the clean, efficient and well-run buses they had before. But at least they can now confidently put their money in regulated state banks.

A Second Look

By 1988, Pinochet had convinced himself that the country and his institutionalizaton of the reforms he had instituted were ready for the plebiscite. In an act of hubris so typical of right-wingers and the neoliberal ideologues, he held the plebiscite, confident of victory. The only problem was that he lost. Even with all the spoiled ballots and stuffed ballot boxes, the refusals to vote, the vote rigging that was rampant, Pinochet still could not claim a majority of the votes cast. He had to admit to defeat. It was a bitter pill for the old man to have to swallow. His neo-liberalism, as well has his right-wing authoritarianism, had made him the most hated man in all of Chile.

The people of Chile had had enough of Pinochet and his "neo-liberalism," yet they were saddled with a constitution that virtually institutionalized both Pinochet and what "neo-liberal" reforms remained. So even though he was officially gone, he was still the power behind the scenes, and everyone knew it.

 Now, twenty seven-odd years on, we can see the long term results of "neoliberal" economics: From the beginning of the reforms of the Chicago Boys in 1973 through 1986, there was no economic growth. Real mean salaries, adjusted for inflation, have declined by 10% since 1986 and by 18% from what they were during the Allende years. Median salaries have fared even worse, declining by 30% over the same period, signaling a torrent of wealth from the poor and middle class to the rich. When Allende was in power, less than 20% of the country lived in absolute poverty; by 1990 40% did. That figure has remained largely constant since. A third of the nation now survives on less than $30 per week. Some miracle, indeed!.

Enthusiastic supporters of the Pinochet reforms like to point out that since 1986, there has been a 7 percent annual growth rate; what they fail to mention is that this occurred only after 1986, after privatization of the banks was reversed, and collective bargaining rights and minimum wage laws were restored; after jobs-creation programs were instituted and privatization of the principal source of foreign exchange was reversed. And they fail to point out that all of that additional wealth has gone into the pockets of the few; the middle class and poor have seen none of it. The much-ballyhooed privatized Social Security system, which is being held up as a model for the United States to follow, is seriously being considered for re-nationalization, since the public system that runs alongside it is producing vastly better results (almost twice the benefits of the private systems). When it was privatized, those who opted to remain in the public system are sure glad now that they did.

Yet the remaining "neo-liberal" reforms continue to bite. The reforms are the reason why nearly all of that much ballyhooed annual growth has gone straight into corporate profits that benefit the rich, and less than ever into the pockets of the poor and working classes - note the declining median income as mentioned above. Milton Friedman and his Chicago Boys are quite well aware of this, but simply don't care, because social justice is not their concern. All that matters to them is the increase in Gross Domestic Product - evidence of economic growth. The fact that it the increase is going entirely into the pockets of a tiny handful of the rich, suits him just fine. Remember, in his view the wealthy are wealthy because they deserve to be - and the same for the poor. As he often said, fairness was not an issue for him - the theory is apparently more important than the results of the theory - in other words, it was a religion, not a science.

Consider that even in the United States, which is hardly a paragon of equitable wealth distribution, 60% of economic output goes into wages, and 40% into corporate profits. Yet in Chile, those numbers are exactly reversed. Chile now rates as the seventh worst nation in the world for equality of wealth distribution - tied with Kenya and Zimbabwe. Nearly all of the wealth being generated by the 7% growth rate is going straight into the pockets of a tiny number of the elite - and the only construction boom in the country in the last fifteen years has been going on in the very richest suburbs of Santiago.


The Salvation of Chile

The salvation of Chile, then, to the extent it has had one, clearly wasn't Pinochet, nor was it the Chicago Boys. It was a recognition by Pinochet, however reluctantly, and in however limited a fashion, that the "neo-liberal reforms" had led to intolerable levels of misery and social unrest.It was, in fact, the re-introduction of many of the reforms that had been originally introduced by Salvador Allende.

As Greg Palast, an investigative journalist for the British Broadcasting Company noted, there was a miracle, all right, but "it was bright red." That was the color of Allende's alleged Marxism.

In essence, the salvation of Chile was at least a limited abandonment of free-market fundamentalism and the "Chilean Miracle." It was a recognition that the free market simply does not solve all economic problems, but actually creates many of them, and ignores completely the social consequences of economic decision-making.

What Went Wrong

What went wrong was simply the failure of Milton Friedman and his Chicago Boys to come clean about their real agenda, which is not to eliminate poverty or elevate the working class. What went wrong was that the dogmatism of Milton Friedman in his role as an intellectual poodle of the ultra-rich, rather than being an honest broker of economic policies intended to "lift all the boats" - not just the yachts tied to the pier, while threatening the skiffs sitting on the beach.

What went wrong was America's own preoccupation with free-market fundamentalism, and our failure to look beyond the surface propaganda, and our complicity in forcing a discredited and defective economic model on others reluctant to accept it.

But what went wrong mostly was the complete and utter failure of Friedman and the Chicago Boys, Pinochet and his American backers, to consider that economic activity does not occur in a vacuum. It occurs in a social and moral context, and economic decisions have social consequences that simply must be considered. And failure to do so can have severe social consequences that feed back into the economic decision-making, and thereby undermine the theoretical framework of the economic premises on which the decisions were based.

What Really Works

There are examples of nations that have lifted themselves from Third-World status into First-World status--. Japan, Taiwan, Thailand, Singapore, South Korea, the nations of Western Europe, all come to mind. Other, more recent examples of nations that have begun to lift themselves up are also relevant. Even the United States was once a Third-World nation, and it too had to lift itself up.

How have these nations managed to reduce poverty and improve the standard of living of their inhabitants? It turns out that there are several factors that are common to all such nations. These factors are well-known to economists, and aren't considered controversial anymore, except to free-market fundamentalists. It is really rather simple, and there are four key factors, and they all contradict the conventional wisdom of free-market fundamentalism:

First, tariff barriers that protect targeted local industries from ruinous foreign competition and allow governments to incubate local industries through subsidy and import substitution. This is how the American steel industry came into being. In the 1860's, most steel in the world, including most of what was used in the United States was produced by Europe. By 1900, the situation was reversed. This situation was accomplished through the use of tariffs in the United States to generate the cash used to subsidize exports. The same thing happened with the American agricultural sector - tariffs kept cheap foreign food out, while the U.S. government fostered the growth of a strong and vibrant agriculture through targeted subsidies, the university extension program, and the creation of a rural transportation infrastructure. Once these programs were complete, tariffs were reduced and subsidies reduced or eliminated. The result is that American agriculture now feeds not only America, but much of the world.

Second, government has to work carefully and judiciously with local business to stimulate research, development and the improvement of efficiencies so that they can compete on world markets, and enforce discipline by removing support from players who do not improve their economic efficiency or the quality of their output. An example is the American agricultural industry. It went virtually nowhere in world markets until the U.S. Congress created the university extension system, with its local offices and agents that helped farmers come to understand what they needed to do to produce economically and efficiently enough, with sufficient quality, to compete in world markets. This is how first Japan, and later Korea and Taiwan have become world leaders in the production of consumer electronic goods, and did so in less time than it took Pinochet and the Chicago Boys to ruin Chile's economy.

Third, economic planners have to come to realize that you can't sell something to somebody who has no money - so social justice issues do matter in a purely economic context, even if, like Milton Friedman, you are unconcerned about the moral issues of social injustices. If all economic productivity is absorbed by a tiny elite through power accumulation created by capital accumulation that is not shared through living wages, there is no purchasing power left in an economy to create markets for the goods produced. Government simply must not allow wealth to become excessively concentrated, however that is accomplished. It can avoid this by using taxation of business profits, inheritance taxes and other such means to prevent the excessive concentration of wealth, and use the monies derived for programs to alleviate poverty and social deprivation, and create educational and economic opportunities for the poor. If that sounds like socialism, that is not an accident - socialism is one means (though not necessarily the best) of attempting to do just that.

Fourth, some exports have to be stimulated by subsidy and some imports restricted by tariffs. Relying on "comparative advantage" simply doesn't work in the real world. Is the automobile industry located in Detroit because Detroit has a comparative advantage? No. It is there because that's where Henry Ford happened to be living when he decided to get into the automobile business. Is Boeing located in Seattle because Seattle has a comparative advantage in aircraft production? No. It's there because that's where the Boeing family happened to be living at the time Boeing's founder decided to start the company. The notion that a nation should stick to doing only that in which it has a "comparative advantage" is also ludicrous when you stop and think about it. Bolivia has a comparative advantage in only one thing - beef production. Does that mean that all Bolivians should want to be gauchos? Hardly! Bolivians want to do the whole range of things that other people in other nations do, and the tax, tariff and subsidy structure of the Bolivian government should reflect that. Additionally, nations, like families, have to earn their keep. For a nation, it is foreign exchange - you cannot buy with other countries' currency when you don't have that currency to spend. So to control purchases and to stimulate sales to keep current accounts in balance, nations, like families, simply must control imports and encourage exports, whether through tax policy or by adjusting the value of the national currency. There is no other way in the long run. At some point, imports and exports have to come to a monetary balance.

Since this is already well understood in the academic world, why is it so controversial? Why are these points so vigorously disputed?

Why do the IMF, WTO and World Bank Aggressively Promote Such Defective Dogma?

There is a widespread assumption that the people who run the International Monetary Fund, World Trade Organization and the World Bank are well-meaning, sincere people who really want to make a difference in the world, helping end poverty and deprivation. And for most of the bureaucrats who work in those institutions, that's true.

This belief is understandable; it is, after all, these institutions that were created specifically for the noble purpose of empowering the poor and disadvantaged. If these people weren't sincere, and weren't there to make a difference, they would be quickly replaced, wouldn't they?

It is certainly a comforting assumption to think that they would be. After all, the stated purpose of these organizations is to solve the problems of world poverty, end hunger, disease and want and the wars these problems create. Why should anyone think that these organizations aren't really sincerely making an effort to solve these problems?

Well, for a start, there's Chile. If these organizations had made any effort at all to study what these doctrines have had in Chile, they'd quickly realize that these doctrines simply don't work as advertised. And it's not just Chile, either. These doctrines have had a dramatic effect in Mexico, where the institution of these policies have caused real wages to decline from $1.32 per hour on average in the in 1970's to only 45 cents per hour today, after the imposition of NAFTA. And they're still declining. The real output of Mexican industry has declined several percent since the North American Free Trade Agreement was signed. And it is still going down.

Beyond Mexico, the destruction of other economies, particularly Argentina, also stand out as dramatic examples of the failures of "neo-liberal" policies. Argentina once had an economic output that was equivalent to most nations in Europe. But no more. More than half of its population now lives in abject poverty, the unemployment rate exceeds 30%, real wages are dropping dramatically and economic activity is shriveling at the rate of 25% per year. Why? Because the very same prescriptions imposed on Chile have been imposed by the IMF and World Bank on Argentina, which followed them willingly and to the letter.

Who killed the Argentine economy? The IMF did. And what is truly shocking is that it knew exactly what it was doing. It was part of a deliberate, calculated plan. That's a shocking allegation that I wouldn't believe myself if there weren't proof of it.

Greg Palast, an investigative reporter for the BBC and the Guardian, a British daily of considerable reputation, has obtained documents that are truly a smoking gun. One is a "technical memorandum of understanding" dated September 5, 2000, signed by Pedro Pou, the president of the Central Bank of Argentina. In it, he agreed to largely the same conditions that killed the Chilean economy:

·         A twenty percent reduction in the budget deficit, at a time when the economy was poised on the brink of a recession - not a very bright thing to do, when all economists agree that under recessionary pressure, budget deficits should actually be increased, not reduced, even if that means temporary spending deficits.

·         Under a boldface heading, titled "improving the conditions of the poor," Argentina agreed to drop salaries in the emergency employment program by 20%. How reducing salaries benefits the recipients remains unexplained.

·         A 12-15% reduction in the salaries of civil servants. With less money to spend, of course they spent less. Not a happy thing to have happen during a period of economic contraction and tight money supplies.

·         A currency peg of $1 to each Argentine Peso, in spite of the fact that there was downward pressure on the Peso. Pegging a currency when there's downward pressure on it is a guaranteed formula for a reduction in economic activity - imported goods become cheaper, so locally produced goods competing with them become less competitive - and the people who were producing them get laid off during a time of lowering economic activity. Not a wise plan.

To finance this scheme, Argentina agreed to borrow the $128 billion in foreign exchange to support the peg scheme at an interest rate of 16%. The interest, at 16%, therefore comes to $27 billion per year, a billion more than the $26 billion in the loans for which these concessions were extracted!

How do the Argentine people benefit by taking out this loan? They don't! As you can see, they actually lose money! Why, then, did the IMF even propose such an absurd scheme? And why on earth would Argentina agree to it? It all makes sense when you start to look at the principals involved, who they are, and how they benefit.

Who benefits by all this and how did they get Argentina to sign such a ridiculous loan document? One must understand who the IMF is and what its agenda is. The International Monetary Fund was one of the three institutions set up in the Bretton Woods Conference at the end of World War II. It was created at the insistence of the great economist, John Maynard Keynes, who insisted that it was necessary to help smaller nations overcome the limitations imposed by their economic size, and help them avoid the misery of economic declines, such as the Great Depression, which was fresh in the memories of conference participants. Large nations like the United States could avoid such declines by careful monetary and fiscal policy, but this option simply was not open to smaller nations. So the U.S., in concert with other nations, created this fund to help smaller, poorer nations work around the limitations imposed by their size.

Until Milton Friedman's "neoliberal" crowd arrived on the scene, it largely behaved that way. But the advent of "neo-liberalism" created an opportunity for the kingpins of international finance to use the IMF as basically an extortion and bill-collecting mechanism. The imposition of Friedman's long-discredited policies, in spite of their horrible social costs, made it possible for the international megabanks to use the IMF to collect outstanding loans. Seizing that opportunity, they used their influence to make sure that their people were installed in positions of influence in the IMF. The result has been that the IMF has been hijacked, and has become essentially a means by which international finance force borrowing at extortionary interest rates, and then collect their loans, no matter how much misery this causes.

It doesn't end there. Others, seeing an opportunity to use the IMF to create and exploit bankruptcy on a vast scale, have also moved in like greedy vultures, using the bankruptcies created by IMF policies as an opportunity to purchase national assets at bargain-basement prices. A classic case is the privatization of water utilities. Using the rubric of "privatization," this means that the poor often find themselves paying vastly more for water, prices they often cannot afford. So the newly-privatized water utility, no longer willing to subsidize water supply to the poor, cuts off the water, and the poor end up carrying water long distances, often from contaminated sources. The result is lowered economic performance (spending time carrying water and recovering from water-borne illness), more disease and the higher social costs to society that result from that disease and child mortality. Even if one does not consider the inhumanity of depriving people of clean, subsidized water, the raw economic costs end up higher, by far, than the presumed "efficiency" gained by private operation of the water utility. When these utilities are privatized, they are usually sold to large foreign multinationals who expatriate the profits - and those expatriated profits become a foreign exchange liability against the country (raising the cost of imports and discouraging other foreign investment), instead of being reinvested or offsetting taxes at home. The hard, basic fact is that economic decisions don't occur in a social vacuum. But "neo-liberalism" fails utterly to consider that to be a problem.

This subversion of the goals of the IMF and its hijacking by the "neoliberals" has meant that this only source of credit to many nations has made those nations vulnerable to blackmail. All nations require credit, not just to finance infrastructure projects, but to finance imports as well. This was one of the goals of the IMF - to facilitate that credit. But when a nation finds itself spending more abroad in finance costs than it takes in export sales, as many third world nations do, it must seek help in financing the debt that creates. That vulnerability means that nations often have to do what the IMF wants - even if it is extortionary. So the people of the Third World lose, and the international bankers and multinational capitalists win. Once again. Neo-liberalism is another term for neo-colonialsim, let us not entertain any illusions about that bitter reality.

Further proof, if any were needed, that those who have the gold, make the rules. And they make the rules to suit themselves - and the rest of us be damned.


Birns, Laurence, editor, "The End of Chilean Democracy"

Blum, William, "Killing Hope: U.S. Military and C.I.A. Interventions Since World War II"

Cooper, Marc, "Twenty five Years After Allende" The Nation, March 23, 1998

Foran, John, University of California, Santa Barbara,

Palast, Greg, "Miracle Cure, But The Medicine Was Bright Red,"

Parenti, Michael. "Serving The Few,"

Ruess, Alejandro, "Invisible Hand and Iron Fist" Dollars and Sense magazine, Nov.-Dec., 1999