Economic Growth and Income Distribution in Chile: Macroeconomic Trade-Offs Revisited

Abstract

Long run sustainable development requires both sustained growth and an equitable distribution of the fruits of growth and modernization. This paper analyzes the issue of maintaining the dynamic growth momentum of the Chilean economy while at the same time reducing poverty and improving income distribution patterns. The paper identifies the major constraints on growth for the Chilean economy and develops a macro model to explore and quantify potential trade offs between growth, poverty reduction and distribution. The model is calibrated with parameters for the Chilean economy and used to examine the effects of various macro policies with distributive content. For example the model shows that an unbalanced increase in government spending (in social sectors) of 3 percent of potential GDP, will slow down the rate of growth of GDP by 1 percent, the real exchange rate appreciates (5.4 percent) and real wages rise (4.4 percent) in a capacity constrained-growth regime. The cut in government savings is the driving force behind the deceleration in growth, given a certain current account deficit. The adverse side effect on growth of the social program can be avoided with an increase in taxation or a reduction in other public spending items in order to prevent a decline in public savings.