The Pinochet government eliminated the bargaining power of workers by suspending collective bargaining and prohibiting union activity. Wage readjustments were decreed by the government. These adjustments were based on partial indexation to past inflation in 1974-75, and on total indexation beginning in 1976. Total indexation to past inflation combined with declining inflation resulted in rising real wages. Employment growth was sluggish in the mid-1970s, and the government’s main solution was a program in which the unemployed performed public works for reduced wages.
This was a paradoxical time in Chile’s economic history, a time that some Chileans referred to as the “boom”. Output growth averaged 7.9 percent per year from 1977 to 1981, the availability of imported goods increased dramatically, and inflation finally fell to 9 percent in 1981 (see Tables A1 through A3). But not all Chileans were taking part in this “boom”: unemployment remained stubbornly high at 15 percent, real wages were still 27 percent below their 1971 level, and income inequality was worsening as the richest 20 percent were gaining an ever-larger share of income.
The Labor Plan of 1979 of Labor Minister Jose Pinera did little to cheer the working class. The new labor law greatly reduced workers’ bargaining power by further repressing labor unions, restricting collective bargaining to the firm level, allowing for termination with loss of severance pay when strikes continued for 60 days, and allowing for arbitrary dismissals. General Pinochet, however, stated proudly that the new labor law “assures workers an increase in remuneration of at least 100 percent of the increase in the cost of living” through its mandatory 100 percent indexation of wages to past inflation.
Financial liberalization begun in 1974 with privatization, the removal of credit and interest rate ceilings, and a drastic reduction in reserve requirements (from 85 percent to 10 percent on demand deposits) was completed in April 1980 with the removal of controls on foreign borrowing by banks. (see Table A9 for measures of savings.) The large Grupos had benefited greatly from the government regulations on private capital mobility as they did have access through their banks to private foreign lending. Since the grupos were able to borrow at relatively low international interest rates and lend at high Chilean lending rates, they were able to earn large arbitrage profits.
The grupos practiced unbridled self-lending (for example, in 1982 Banco Santiago granted 42 percent of its loans to its grupo) to expand into the export sector, getting heavily involved in timber, mining, paper and fishing. However, as prices in Chile rose relative to those in foreign markets, export profitability declined substantially. In late 1980 a number of grupo-related firms started to face serious financial trouble, but were kept afloat thanks to the refinancing of bad loans. In April 1981 the grupos
’ financial fragility became apparent not only to the Chilean authorities but also to international lenders as the Crav grupo declared bankruptcy.
The abundance of foreign credit in the early 1980s provided the financing necessary for the unsustainable explosion in private expenditures at the time of the boom. By the end of 1981 Chile was burdened by a large foreign debt and an insolvent domestic financial system (see Table A8). The fixed exchange rate combined with backward wage indexation and the massive capital inflows to lead to a 35 percent real appreciation, which greatly reduced the competitiveness of the export sector. In 1982 the bubble burst: real output collapsed 15 percent and the unemployment rate shot up to 30 percent. Real interest rates rose, the currency was devalued sharply, and roll-over of domestic debt was curbed. In 1982 over 800 firms declared bankruptcy and in 1983 regulators had to reassume control of the five largest private banks.