Chile’s Old Guard Counts on the Free Market to Save the Economy

Juan Andres Fontaine and Jose De Gregorio have been guardians of Chile’s free-market economy for more than three decades – as central bankers, economy ministers and professors.

A customer pays with a 5,000 peso bill in Santiago, Chile.
By Valentina Fuentes and Eduardo Thomson
November 12, 2021 | 10:09 AM

Bloomberg — Juan Andres Fontaine and Jose De Gregorio have been guardians of Chile’s free-market economy for more than three decades -- as central bankers, economy ministers and professors.

So, like many of the old guard in Santiago, they’ve watched with trepidation as widespread street protests have led to a raiding of Chile’s vaunted pension-fund system, a push to rewrite the constitution and the possible election later this month of the country’s first hard-left president since the ill-fated Salvador Allende in the 1970s. Latin America’s wealthiest economy, Fontaine says, “is going through a minefield, wherever one looks there’s the possibility of a dangerous explosion.”

The one thing giving them hope through it all: That the Chilean economic model is so open and so free-market oriented that it should act as a safeguard. Any radical changes, as they see it, will spark such an intensely negative reaction in markets that the costs will compel the government to moderate its policies.

Jose De Gregorio, professor of economics at the Universidad de Chile, arrives for a dinner during the Jackson Hole economic symposium, sponsored by the Federal Reserve Bank of Kansas City, in Moran, Wyoming, U.S., on Thursday, Aug. 24, 2017. dfd

“An open economy punishes very quickly those adventures some politicians wish to embark on,” Fontaine says. The market, once riled up, “kicks very hard.”


Signs of this are already becoming evident in the run-up to the vote. The Chilean peso is among the world’s worst performing currencies this year. While the local bond market has fared better in recent weeks, benchmark yields are still up 120 basis points in the past three months. Swap rates reached a nine-year high in October.

The two come from different political camps -- one on the conservative side of things, the other a bit more to the left. Fontaine, who worked in the center-right administration of President Sebastian Pinera and as director of research at the central bank, and De Gregorio, an economy minister for former center-left President Ricardo Lagos and former head of the central bank, joined Bloomberg News reporters on Zoom for a discussion of what comes next for Chile.

They don’t see eye to eye on everything but one thing they agree on is that the grievances reverberating across the country’s working-class neighborhoods have some merit. While the framework established by the former dictator Augusto Pinochet and the group of so-called Chicago Boys economists in the 1970s and ‘80s (which included Fontaine) set Chile in a path of extraordinary growth and progress, politicians failed to make minor adjustments over the years that could have solidified the social safety net. That political failure is to blame for the unrest and people’s rage, they said.

Swap rates reached a nine-year highdfd

“For years politicians followed a thesis of ‘If it ain’t broke, why fix it?’ and that was a big mistake,” said De Gregorio, who now is dean of the faculty of economics at the Universidad de Chile. The strategy led “us to a huge polarization, with populists prevailing.”

The system’s popularity will get tested in the presidential vote set for Nov. 21. The two front-runners -- the leftist Gabriel Boric and conservative Jose Antonio Kast -- are at opposite ends of the political spectrum. Kast pledges cuts to corporate and wealth taxes, as well as tougher migration policies. Boric -- who some polls favor to win a runoff in December -- promises to bury Chile’s “neoliberal” model.

One of the most contentious issues are the private pensions that are among the most revered aspects of Chile’s financial system, and a model for countries around the world. By law, every Chilean worker must contribute a portion of her salary to a personal fund. But many Chileans say the returns have been lackluster, not enough to provide them with a secure retirement. And they’re suspicious of the financial companies that manage their money.

Chilean lawmakers pushed through legislation allowing three rounds of extraordinary pension fund withdrawals since the pandemic started, totaling about $49 billion. The measure has proved popular among Chileans who needed cash to get them through Covid lockdowns, but it has undermined local markets and helped push inflation far beyond the central bank’s target.


While Kast advocates for the system to continue as is, Boric proposes scrapping it entirely in favor of a state-run manager. Fontaine says it’s the single proposal he’s most worried about, both because of the risk to savers and the potential damage to Chile’s capital markets, which depend on flows from private pensions.

“The solution they are suggesting aggravates the problem,” he said. “I have serious doubts about the state’s ability to respond with good pensions in the future, in addition to the problem of bad incentives the state would have to manage those resources.”

As economists like Fontaine and De Gregorio contemplate what the future holds, it’s become a popular parlor game in Santiago to guess which Latin American country Chile will most closely resemble in a few years time.


De Gregorio says it’s most likely that Chile -- after some reforms to take the heat off the incoming administration -- could end up resembling Peru. There, state intervention has produced a generally stable economy with consistently lackluster growth.

Fontaine says his most optimistic take would be for Chile to end up like Mexico, where the government has a larger presence in the economy, but the framework is supported by free-market pillars.

But he doesn’t rule out a future in which the government starts closing the economy, turning inward in an attempt to shore up the safety net and provide work for a restive populace. If that comes to pass, he said, Chile could end up resembling Argentina, a country perennially beset by a weak currency, steep inflation and sluggish growth.

De Gregorio doesn’t think it will come to that.

“What gives me hope is that when an ideology reaches a moment when it stops producing progress, that government has no other choice than to postpone its program,” he said.