Analysis of Income Economic Inequality in Chile and Peru

Inequality, in its myriad of social and economic forms, is a persisting issue in Latin American society. As of 2014, Latin America was found to be the most economically unequal region in the world: just 10 percent of the richest Latin Americans controlled 71 percent of the region’s wealth (Ibarra, 2014). When wealth is concentrated in the hands of the few, often so is power. It is argued that, for many Latin American nations, this is partially due to political systems being heavily skewed in favour of the business elites. Moderately high levels of corruption in the region stem from the capacity of undemocratic and populist politicians to exploit weak democratic institutions (Transparency International). When the interests of the elites are protected, it is at the expense of the well-being of the poor majority. In comparison to developed countries, Latin American governments spend 11.4 percentage points of GDP less on social services such as education, health, pensions, and infrastructure (Melguizo, 2017). Lack of social investment restricts inter-class mobility, reinforcing disparity both systemically and culturally. It is important to clarify is that wealth and income inequality is a representative of institutional capacity, not macroeconomic stability. Over the past few decades, Chile and Peru have both experienced extensive export-led economic growth and managed to more than double their respective GDPs in just under 30 years (Madison Project Data Base). Despite reduced levels of extreme poverty (World Development Indicators), Chile and Peru continue to be included in the 50 most economically unequal countries in the world (World Bank Estimate, 2015). Without effective redistribution methods, the previous economic growth was at the expense of equity. I will argue that income inequality in Chile and Peru is partially due to the legacy of authoritarian- and dictatorship-era neoliberal reforms, which continue to undermine the integrity of political institutions via systems of taxation and privatization.

Modern political institutions in Latin America struggle to navigate the persisting contours of neoliberal reforms from the late 20th Century. In response to the failure of Import-Led Substitution Industrialization, Chile sought market liberalization under the military dictatorship of Augusto Pinochet (Ibester, 2011). Economic growth was achieved via dramatic reductions in governmental regulatory and provisional capacities. Almost 20 years later, populist leader Alberto Fujimori would be responsible for the adoption of similar reforms in Peru (Stokes, 1997). In both cases, economic growth was extensive and socially exclusive. Following Import-Led Substitution Industrialization, institutions in Chile and Peru were weak, which allowed the actors from the private sector to integrate into political positions. Over time, an embedded network of elites accrued within each respective government (Fairfield, 2015). According to José Carlos Orihuela (2013) of the Pontificia Universidad Católica del Perú, these original political business elites prioritized “macroeconomic stability, aggressive trade integration, and business-friendly investment climate” (p.143). However, what they would end up truly prioritizing is the exclusion of the poor majority.

The neoliberal models adopted during the regimes of Pinochet and Fujimori continue to restrict avenues of national revenue, which inhibit modern Chilean and Peruvian governments from investing in social services to ease economic inequality. In terms of public financing capacities, the InterAmerican Development Bank advocates for taxation to be perceived as more than just a revenue tool. It stresses that a strong public financing capacity is critical in the development in social policies for growth and equity (InterAmerican Development Bank). The OECD reports that while tax revenues in Latin America continue to rise, they are lower in proportion of national income than most OECD countries (OECD, 2019). This relationship is not coincidental, as regions with higher inequality have been shown to develop tax systems with lower revenues (Ducong et al., 2018). In 2017, the total tax revenues as a percentage of GDP for Chile and Peru were less than half of those of major industrialized countries (OECD, 2016). High levels of taxation run in opposition to the neoliberalist beliefs instilled by Pinochet and Fujimori. Consequently, the modern tax systems of Chile and Peru prioritize economic growth rather than redistribution.

The United Nations Economic Commission (UNEC) for Latin America claims that European systems are 6 times more effective at redistributing wealth and reducing inequality than those within Latin America (Ibarra & UNEC, 2016). The majority of income tax systems in Latin America were not designed to service the interests of the wage labour majority, but instead aimed to incentivize the investment of capital-owners. It estimated that the average tax rate for the richest 10 percent of Latin Americans amounts for just 5 percent of their disposable income (Ibarra & UNEC, 2016). Structurally, income taxes in Chile and Peru are designed in favour of capital owners, as in both countries business elites maintain a greater influence in politics. In simplified conditions, income can only be taxed via wage-labour or capital wealth. For waged labourers in Peru and Chile, personal income tax is automatically deducted from their paycheque. However, taxing capital wealth is far more complicated and requires great administrative resources in order maintain accountability and transparency. Therefore, even though Peru and Chile have experienced marginal increases in corporate tax rates (Fairfield, 2015; Ibarra & UNEC, 2016), high-income sectors have access to the resources to avoid and evade these direct taxes (Ibarra & UNEC, 2016) – especially when institutions are weak. In Latin America, it is estimated that 4 percent of GDP is lost to tax loopholes (Ibarra & UNEC, 2016). Studies show that Peru is one of the region’s economies with the highest level of income tax evasion, which is estimated at 48% (Gómez-Sabaini and Jiménez, 2012).

Income inequality can also be affected by different forms of taxation. The common one found in Chile and Peru being a form of indirect tax, which are notably burdensome on lower-income citizens, called the value-added taxation or VAT. Targeting consumer goods and services, VAT is inherently regressive because it comprises a larger percentage of a low-income budget than a high-income budget. In 2005, former Chilean Finance Minister Eyzaguirre (Fairfield, 2015) explained: “If you compare the tax structure of Chile with U.S. or others, you will see that the proportion of indirect taxes – taxes on consumption – over the total tax burden is very high, and the proportion of direct taxes to ones that are more proportional to the level of wealth are very, very low” (p.23).

Resistance to change the tax burden, Eyzaguirre continued, is entirely a “political problem” (Fairfield, 2015). The persistently low tax levels of Chile and Peru echo their respective eras of neoliberal reform and aim to protect a free-market and small-state economy. The “political problem” that Minister Eyzaguirre is referring to is the belief that by concentrating capital in the hands of the elite, it will maximize their capacity to invest, and wealth will diffuse across the economy. This economic model, coupled with the weak institutions populated by the elite, does not encourage entrepreneurship (Mehlum et al., 2006). Under these conditions, reduced regulation incentivizes producers to become rent-seekers, and to pursue profits via corruption (Mehlum et al., 2006).

In response to the economic chaos of Peru in the late 20th Century, populist leader Fujimori administered widespread neoliberal reforms in order to pursue national macroeconomic stability. Peruvian mining operations were especially deregulated: reduced import tariffs, export tariff removal, streamlined foreign licensing, and relaxed indigenous land tenure (Bury, 2002). These reforms, coupled with Peru’s abundance of natural resources, attracted extensive direct foreign investment (Bury, 2002). However, it is speculated that the resource abundance of an institutionally weak country may increase the concentration of rent-seeking elites (Mehlum et al., 2006) and compromise the quality of democratic regimes (Ducoing et al., 2018). Referred to the “natural resource curse” (Sachs & Warner, 2001), there is some evidence to suggest that there exists a negative relationship between the share of natural resource exports to GDP and the long-run economic growth rate. In response to this phenomenon, transnational corporations were required to pay royalties to the Fujimori administration (Bury, 2002). A portion of these royalties were meant to be returned to the local communities which the mining operations affected (Bury, 2002). However, as an effect of the corruptive nature of weak neoliberal institutions, this failed to become a reality. In 2002, socialist opposition congressman Javier Diez Conseco led an investigation into the Fujimori redistribution systems (Congreso de la República de Peru, 2004). It was found that the privatization of hundreds of state-owned enterprises raised upwards of USD 9 billion, yet only a small fraction ever reached the hands of the Peruvian people (Congreso de la República de Peru, 2004). Fujimori-era neoliberal reforms have left a legacy of privatized and deregulated mining operations in Peru, which continue to stunt avenues of national revenues. This has left public services underfunded and access to quality education, healthcare, and social security is highly segregated.

The influence of Pinochet-era neoliberal privatizations in contemporary Chile are far more explicit, as it is still subject to the same constitution that Pinochet drafted in 1980. At the birth of the constitution, prominent elites were permitted to purchase formerly state-owned enterprises at little or no price (Torche, 2005). From thereafter ownership of social services was concentrated in the hands of the economic elite. Modern Chile possesses one of the world’s most high privatized economies, as even water is a privately traded commodity (Baer, 2014). Carlos Orihuela (2019) explains how Chilean public policy is compromised by the constitutional integration of business elites: “While beliefs shape behaviour, private interests also play a role. All policy experts face individual economic and political incentives, which can lead to conscious concessions of reason to interest- or to unconscious mental shortcuts” (p. 145). The concessions that Orihuela refers to are made at the expense of low-income citizens which do not have the resources to access social services when they are a private good.

The most notable of Pinochet’s privatizations was delegating the administration of social security to the private sector (Borzutsky, 2018). This created a new type of for-profit enterprise that continue to face little competition: pension fund managing corporations (Borzutsky, 2018). Just three firms account for 86 percent of all social security operations. This extent of market power has increased fees and by 2007, about 50 percent of the Chilean population were excluded from the private social security system (Borzutsky, 2018). The healthcare systems in Chile and Peru are similar in both structure and inequity. The public health sector acts solely to subsidize the private sector (Mesa-Lago, 2005; OECD, 2016).

Private out-of-pocket expenditure on health in Chile is the 3rd highest among OECD countries The high burden of out-of-pocket spending creates barriers to access health care services (outside of the basic benefit package), particularly for low-income groups and highlights the need to prioritize funding of social services (OECD, 2016). What appears to relay into other social services is the discrimination of women. Access to a minimum pension program in Chile is far more costly for women because they have longer life spans (Mesa-Lago, 2005). The discrimination of women is similar in the privatized healthcare systems of both Chile and Peru.

The neoliberal economic programs instilled by both Fujimori- and Pinochet-era governments, which emphasized the deregulation and sale of government enterprises to the private sector, have destabilized each respective welfare state in the long-run. Max Skidmore (2018) claims that the exacerbation of income inequality has “demonized” (pp.525) the welfare state in the eyes of macroeconomic well-being. By concentrating wealth upwards and withdrawing governmental provision from social services, Chile and Peru have entrapped themselves in a fanatical pursuit of never-ending economic growth. However, these neoliberal doctrines are fracturing in the wake of civil unrest, causing constitutional crisis in both Chile and Peru. This is especially prevalent in Chile, which is the most unequal member of the OECD. Despite having the highest GDP per capita in South America, the richest 1 percent of the Chilean population earns an overwhelming 33 percent of the nation’s wealth (Melguizo, 2017). Protests have erupted throughout the region, mostly concentrated in the capital city of Santiago. Protesters are calling for constitutional reform, citing Pinochet’s legacy as a root cause for the inequality. President Sebastián Piñera has recently promised to administer a marginally higher tax on the rich, which is one of the many demands of the protest. Peru has seen a corresponding increase in civil unrest and in September of 2019, dissolved congress in response. The outcomes of each movement are only up to speculation, but is appears that the majority are no longer willing to be passive in their oppression. As Pablo Neruda wrote, “For the thieving nobleman, privilege – for the man who steals bread, jail.” Perhaps this will be the generation that will no longer accept this as the rule and demand a future that is as inclusive as it is prosperous.