Chile remains a strong performer, even in relation to the most successful comparator countries in the OECD area. Activity lost some vigour in 2006, predominantly because of one-off factors, rather than structural weaknesses, but rebounded in earnest in the first half of 2007. Macroeconomic management continues to be exemplary, delivering falling public indebtedness, growth around potential and low, albeit recently rising, inflation. The rules-based policy framework – combining instruments for saving revenue windfalls related to business and copper-price cycles with inflation targeting and exchange-rate flexibility – is serving the economy well in a period of unprecedented strength in the price of copper. As a result, economic activity is now much more resilient to the vagaries of commodity prices than in previous cycles. The authorities intend to build on these achievements with an ambitious structural reform programme, ranging from regulatory matters to a strengthening of social protection, including through much-needed further enhancements to social security. The OECD concurs with the authorities’ view that a combination of sound macroeconomic policies and additional progress in structural reform is essential for raising and maintaining the economy’s growth potential over the longer term so as to achieve a faster reduction in the income gap that still exists between Chile and the OECD area. Sustaining high growth in the future is also important for a further reduction in poverty and can do much to improve Chile’s still very skewed income distribution.

Chile’s economic performance remains strong. Growth has picked up since 2003, and the economy is well equipped to weather the effects of copper-price cycles. This is due to a strong policy setting combining a freely floating exchange rate, inflation targeting and a fiscal rule that has delivered a gradual decline in public indebtedness to a net creditor position. Sustained growth over the longer term will be essential for reducing Chile’s still sizeable income gap with respect to the OECD area, reducing poverty and improving income distribution. But more will need to be done to make sure that this convergence process is maintained in the future, especially through sustained policy reform initiatives that can lift the economy’s long-term growth potential. This overarching policy challenge can be addressed through action dealing with three main structural areas: efficiency of government spending on selected social programmes, informality in the labour market and the business sector, and labour force participation among underrepresented groups, females and youths in particular. Initiatives in these policy domains reinforce each other and complement those highlighted in the 2005 Survey, which focused on options for boosting the economy’s business innovation potential and for strengthening the regulatory framework in network industries.

Compliance with the structural budget surplus rule, which has been in place since 2001, has allowed the government to maintain a counter-cyclical fiscal stance in an environment of rising copper prices, while delivering a gradual reduction in public indebtedness. Monetary policy is conducted within a framework that combines inflation targeting with exchange-rate flexibility. A Fiscal Responsibility Law was promulgated in September 2006, strengthening the macroeconomic framework further by embedding the fiscal rule in law and setting out regulations for the use of fiscal savings. Complementary pension reform is being discussed in Congress with the objective of strengthening the pension system’s solidarity pillar and encouraging retirement saving. The tax system is also being improved with a view to removing obstacles to financial deepening and to business-sector development. Government spending on social programmes is budgeted to rise considerably, in line with the authorities’ emphasis on social development. The main challenge in the macroeconomic area is to maintain the policy setting that has served Chile so well over the recent copper-price upswing, while tempering demands for hiking public social spending and maintaining a lean public sector in a low-tax, low-debt environment.

The authorities plan to raise budgetary allocations over the medium term for a variety of social programmes, including education, health care and housing. This incremental spending will need to be carried out in a cost-efficient manner to make sure that it yields commensurate improvements in social outcomes. Chile’s population health indicators show that it fares relatively well in relation to comparator countries in the OECD area and in Latin America. But this is less so in the case of education, where secondary and tertiary educational attainment remain low, despite a significant increase over the years, and performance is poor on the basis of standardised test scores, such as PISA. Even though comparison with countries in the OECD area is difficult, a sizeable housing deficit has yet to be closed in Chile. To meet these various challenges, efforts will need to be stepped up to: i) narrow the disparities in performance that currently exist among schools with students from varying backgrounds through use of the “differentiated” voucher scheme and additional measures to improve the quality of teaching and management; ii) improve risk sharing among private and public health insurers, while increasing the coverage of health insurance to a broader variety of pathologies under AUGE; and iii) continue to tackle the shortage of housing, while enhancing the quality of subsidised housing units and their surrounding neighbourhoods for the poorest segments of society.

Informality often arises from disincentives associated with high taxes and a restrictive regulatory framework in both labour and product markets. About 20% of the Chilean population aged 15 years and above and working at least 20 hours per week did not have a formal labour contract in 2006. At the same time, nearly 11% of the potential value added tax base is estimated to have been undeclared in 2005. While Chile’s tax system is not particularly burdensome to business formality, there is scope for making product-market regulations less onerous to firms and the labour code more flexible, especially with regards to indefinite contracts and the allocation of working time. Low human capital remains an important obstacle to reducing labour informality. To the extent that informal businesses also hire informally, there is some room for designing policies to tackle business informality in conjunction with those aimed at boosting formal labour contracting. Chile is strengthening its social safety net through the introduction of unemployment insurance and by reforming existing health insurance and pension systems. An important policy question is whether the incentives for formality arising from more comprehensive social protection will be strong enough to compensate for the additional costs these contributory programmes entail.

Chile’s labour force participation is low by comparison with most countries in the OECD area, especially among females and youths. In the case of women, labour supply has risen steadily over time for prime-age and older individuals, against a background of relative stability for men. With regards to youths, participation rates are trending down, primarily as a result of rising school enrolment, especially for males, while remaining fairly low and stable over the years for young females. The main policy challenge in this area is to raise female labour supply further, for both prime-age individuals and youths, as a means of making a better use of labour inputs in support of long-term growth. This can be achieved essentially by removing provisions in the labour code that constrain the allocation of working time and by improving access to affordable child care for mothers with young children. Policies aimed at fostering human capital accumulation for the population as a whole would also contribute, because educational attainment is one of the most powerful determinants of labour force participation.