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"Being a Keynesian means being a Keynesian in both the good and bad times."

Andres Velasco (Finance Minister in Chile) [1]

It has been a while since I last had a thorough look at Chile (here and here); more specifically, the last time I had Chile under the loop was in October 2008 and thus around the time when the global economy was about to enter two quarters (Q4-08 and Q1-09) of absolute horror. Whether we are past the worst at this point in time is debatable and I am, personally, skeptical with regards the narrative of second derivatives and green shoots, but it is hard to deny that it does represent a narrative and a fairly strong one too. In this context I thought it would be interesting to have a look at Chile, how it has faired and how we can expect it to fair in the immediate future.

It will immediately become clear as we move forward through the data that Chile is a bit unique both in a global and most definitely so in a Latin American context. In this sense, and if not for any other reason, the following should confirm that although the global economy is in the midst of the worst crisis since the 1930s, there are some economies who are better positioned than others. In order to pin down some fix points from which to begin this analysis, it is interesting to go back to Q4-2008 and the note by Morgan Stanley analyst Luis Arcantales who pointed out that as the global economy was about to slide, it was Chile's time to shine. This analysis was echoed in the Economist's small article about Chile in which it is argued that Chile is cashing in the fruits of rigour.

The question is then; is this true?The analysis which follows supports this positive view on Chile and I thought it would be fair, at the offset, to identify the two underlying mechanisms for this position.

First of all, Chile has been saving for a rainy day and especially in the context of the copper windfall enjoyed in the past years, Chile have been acting with utmost prudence. Coupled with a big pool of sovereign assets/wealth tucked away in main state investment vehicles (SWF) this provides Chile with an enviable and essentially remarkably positive fiscal profile going into the crisis. The most important aspect of this strategy of prudence has been the joint commitment across political leaderships to maintain a structural fiscal surplus of 0.5% of GDP in order avoid the copper windfall from pushing Chile into a variant of the Dutch disease as well as of course as to lock in savings for rainy day. Between 1996 and 2006, Chile’s public balance averaged 1.5% of GDP and coupled with a substantial amount of the copper windfall parked in the SWF Economic & Social Stabilization Fund (FEES) it has granted Chile with a net debt position of -11% (i.e. a net credit position of 11%).

In addition to the story about the timely management of the Copper windfall, I have also emphasised the demographics of Chileand in particular the fact that the key working age brackets are still growing as a percentage of total population. In many ways, Chile is now moving on the outskirts of the so-called demographic dividend with the age group 25-64 still growing as a percentage of total population whereas the age group 25-44 is declining. It is an empirical fact that such favorable demographic momentum has a strong effect on macroeconomic performance; see e.g. Bloom et. al 2007 and Bloom and Williamson 1998.

However, with fertility coming in at replacement levels in these very years Chile now stands on the boundaries of the much debated second demographic transition (SDT) and it will be interesting to see just how Chile enters this second leg of the demographic transition (if at all). It is important to point out that the SDT is far from an inevitable process, but in it the light of the regularity with which life expectancy has continued to increased at the same time as fertility has steadily moved below replacement levels in one country after another, it is difficult to imagine that Chile won't also enter a new stage in its demographic transition. However, and whatever happens in Chile as we move forward it does not change the fact that Chile has the demographic winds blowing firmly in the back at the moment even if the direction is changing. The key will naturally be the extent to which Chile manages what comes next in terms of demographic evolutions.

Touched, but not Harmed?

Even with this set of formidable fundamentals the global economic crisis has not left Chile untouched. On a quarterly basis the third quarter of 2008 marks the last quarter in which Chile grew at the rates its citizens and policy makers have been used to over the course of the years of abundance leading up to the crisis. Since Q3-2005 the average growth rate of Chile's output measured by GDP was a remarkable 4.5% q-o-q, a figure which clocked in at a puny 0.2% in Q4-2008 and then on to a full blown contraction of 2.1% q-o-q in Q1-2009. In fact on an annual basis, Chile has observed negative growth rates since Q3-2003.

The central bank expects GDP for 2009 to hover around the 0% mark with -0.75% as a low point and the 0.25% as the corresponding best case scenario. This relatively bleak figure is produced by the expectations that domestic demand will contract at a rate of 4.7% of which the expected decline in gross capital formation of of -14.3% which contrasts with a 19.5% expansion in 2008.

This headline forecast naturally calls for all kinds questions not least the impending question, as it is being asked around the world, about the extent to which Chile will ever recover to observe growth rates it did before the global crisis. Personally, I believe that most analysts would agree that the script on 2009 as a horrible year is already written and the question now becomes; will 2010 be the year of recovery or will it be the year of disappointment as the boost from 2009's stimulus packages wane and it becomes clear that any kind of second leg with respect to a sustained pickup in global growth will be very tepid. I tend to lean towards the latter account, but it is also clear that the extent to which the global economy is able to limp forward, it will be economies such as Chile who will be doing a lot of the heavy lifting.

This particular view motivates a lot of what follows.

A Closer Look at Trends in Output and Activity

One way in which to differentiate the GDP measures fielded above is to have a look at GDP divided onto sectors to see how ouput in Chile has evolved over a wide array of activities as well as to compare this to some form of base value. As can be seen from the graphs to the right; I have chosen to focus the attention on cobber, manufacturing, construction, housing property, and financial services.

In the graph to the right the base value 100 is equal to the mean value of output over 4 quarters in 2003 measured at constant 2003 prices. For an economist with an inclination to base his analysis on underlying demographic parameters one thing immediately stands out. Indices for construction and housing property have hardly budged. This is interesting since the main driving force across of the real economic collapse across the globe is, in the case of many other economies, precisely driven by a collapse in these sectors. Now, whether this is because Chile did not entertain the same kind of bubble-like environment as elsewhere or whether it represents the fact that Chile's demographic profile would exactly lead us to the point that these precise sectors should be well supported by the underlying fundamentals I will remain silent. Clearly, it will be a bit of both, but it is a point worth remembering when talking about construction booms and bubbles; there is always an underlying capacity story underneath. This discussion is readily available in an Indian version concerning the risk of overheating which was debated furiously a while back.

Meanwhile, the general trend indicates that although there has been a notable drop in the constant price value (in mill pesos, 2003 prices) activity has not collapsed in any sense of the word and remain well above its base value. Now, there has of course been a decline and the jury is still out with respect to the extent that the decline will continue, stabilise or turn into growth. Most likely growth will resume its due course over the course of h02-2009, but as in all other places in the world it is the level of this growth which may ultimately surprise on the downside. One area where activity has markedly declined since the middle of 2008 is in the context of manufacturing and in this sense it is worth while having a closer look at the underlying pattern here.

If we start by looking at the manufacturing indices in the first difference (change) and represented through a 6-month moving average to try to smooth out the trend for the naked eye we observe the negative trend as it has grapped hold in the latter parts of 2008 and into 2009. However, we also observe that this does not like the horrible charts that we have seen e.g. in the context of the US, Europe and Japan. The average monthly rate of change in the general index through the 12 months ending April 2009 was -0.2% which is not exactly cataclysmic; in terms of the subcomponent the production of durables on the other hand decline at an average rate of a full 2% (mom) whereas the average change in the value of capital goods was 1%.

During the time measured in the graph to the right the general index peaked in March 2008 at 139.7 and bottomed in February at 112.8 after which it has recovered to 123.1 at the end of April. As noted, a large part of the drop in the latter part of 2008 and into 2009 was a sharp decline in the value of production of durables which fell (on an index basis) to a low of 65.9 in February 09. At this point in time the production of durables furthermore remain depressed relative its long term trend. Conversely, the value of production of consumer goods and capital goods have pretty much shadowed the trend in the general index; or more aptly, it is the relative stability of these two indices which have helped the general index to skirt what has been a sharp decline in the production of durables.

Finally and perhaps to end where I should have started it is worthwhile to have a look at the main index for economic activity in Chile (the IMACEC).

Looking at this index it is difficult not to conclude that Chile appears to have managed the initial stages of the economic crisis quite well. Surely, the index is down as one would expect but at this point at least, it does not appear to be a decline which will buck the general trend. The index peaked in June 2008 and has since fallen back 5% at the end of April. The most recent data however confirm that the slowdown is lingering as we approached the second half of 2009 with industrial production dropping 10.5% yoy in May prompting comments from central bank president Jose De Gregorio to note that nominal interest rates could be lowered further from its already low level at 0.75%. Moreover, the monthly GDP indicator showed that Chile continued to contract as we entered Q2 posting yoy 4.6% decline and with monthly inflation rates beginning to post negative readings policy makers and analysts close to Chile remain alert. As we have just rapped up Q2 in real time it appears that Chile is poised to surprise somewhat on the downside in terms of prior expectations.

The External Sector

The analysis of Chile's external balance and the country's currency is of course closely tied to the evolution of international copper prices as Chile is, by far, the world's biggest producer and exporter of copper.

Although copper prices have fallen back somewhat in the midst of the global recession relative to the average values through 2006-2008 they are still higher than they were at the turn of the century when the price of copper were below 1 USD/lb. In fact, the graph should make any trader look more than once since with the recent increase the price of Copper is very close to breaching the its 12 month moving average price although of course the strength of the global momentum in general will decide whether commodities, and thus Copper, will fly again. As an aside, it would be very interesting to run an analysis on the extent to which the recent move upwards in Copper prices has anything to do with the reports that China is stocking up on commodities(it does of course, but how much?)

The positive effect from copper on Chile's external balance has, at times, been coined as the copper bonanza and Chile's ability to manage this bonanza in a prudent manner is one of the reasons that the country stand out in the current environment. In general however, the composition of Chile's external balance look very much like one would expect of course that the current account has been in surplus since 2004 due to the positive impact from the trade balance and thus net exports of copper. Thus, up until the advent of the financial crisis Chile's current account was characterised by a positive trade balance which outweighed a negative income balance to produce a consistent current account surplus. This changed in the latter part of 2008 where Chile posted a current account deficit in Q3 and Q4 as copper prices plummeted and exports in general fell. Basically, the trade balance withered away into a small deficit and with a continuing negative income balance, Chile found itself in need of external financing for the first time in 5 years. It also pushed the current account deficit into deficit for the full year 08 and the central bank, rather surprisingly, expects 2009 to see another CA deficit. I say surprisingly here since Q1-09 has so far posted an overall CA surplus worth 639 billion USD driven by a strong trade balance (mainly due to a plunge in imports and higher Copper prices). In any case, it is difficult to imagine that Chile will any problem financing a current account deficit of the magnitude the central bank is forecasting at 1.8% of GDP in 2009.

Turning the analysis to the currency it is interesting to observe that last time I looked at Chile inflation was running close to 10% and with nominal interest rates below the inflation rate the Chilean economy was experiencing negative real interest rates. In the context of the currency this meant that just as we were rounding up Q3 2008 the Chilean central bank decided to hold back on its frequent endeavors into the market to stem the rate of appreciation of the Peso against the USD. Endeavors, which by the way, have been unable to buck the overall trend in appreciation of the CLP ever since 2003 against the USD.

Of course, events had it in Q4 2008 that markets were to experience a significant amount of stress and rising volatility which sent the Peso down against the G3 currencies where it is only now recovering. In the context of the stress encountered in the market and seeing that the spread on Chile's sovereign debt increased less than the average in Latin America (and Asia) I argued that perhaps this was a sign that Chile's currency would not be hit as hard, in the context of increasing volatility, as its emerging market peers. My argument in a nutshell was that since the Peso was amongst one of the best performing emerging market currencies against the USD (back in April) this was perhaps due to the relatively high standing Chile had with international investors. Stefan Karlsson would have none of this however arguing in stead that the relative strength in the context of Chile's Peso was to be found in relation to the increase in the price of Copper. I conceded that Stefan was right in so far as goes the obvious fact that Copper is a very important driving force for the Chilean Peso regardless of whether investors were also targeting Chile as a relative safe haven amongst emerging markets.

However, in the spirit of good argument I decided to let me and Stefan's arguments suffer the, not always flattering, test of empirical validity. To that end I cooked up the following small model;

Y = a + b1X1+b2X2

Where Y is the exchange between the Peso and the USD (quoted directly), X1 is the price of Copper, and X2 is the sovereign spread. I use monthly data from Jan-00 to May-09 for a total of 112 observations and as per convention I am estimating this model in the first difference to avoid issues of stationarity [2]. Given the hypothesis one would expect a negative sign for X1 (i.e. an increase in the price of Copper is associated with an appreciation of the Peso) and a positive sign for X2 (i.e. an increase in sovereign spread is associated with a depreciation of the Peso). The estimation (with OLS) returns the following result;

Y = 0.0016 - 0.16X1 + 0.09X2 + ut [F = 33.25, R-sq = 0.38]

Now, both variables (X1 and X2) are significant at 1% [3] and thus I am inclined to stick my neck out a little bit more vis à vis Mr. Karlsson and conclude that the extent to which investors see Chile as a relative safe haven amongst emerging markets will in turn make Chile's sovereign debt spread increase less relative to its peers in relation to market turmoil which, in turn, has a measurable effect on the exchange rate.

Don't worry, this will be the first and last regression analysis you see in this note and just to sum up; Copper does matter for Chile and with net revenue expected to drop 69 percent this year to $1 billion from $3.2 billion in 2008, it will have a noticeable impact on Chile's economic performance although I need to emphasise that, to my mind, Chile posseses sound fundamentals which move far beyond the benevolence of its Copper ressources.

Employment

In terms of the labour market Chile cannot escape the fact that the crisis has taken its toll. The latest figure for April has the unemployment rate running at 9.6% which makes it almost certain that it is above 10% in the time of writing. 10% hardly constitute a dramatic number in a relative context (although of course it is big in an absolute sense), but given the fact that Chile entered the crisis running at 7-8% the lagged effect of the recession on the labour market may push the unemployment rate to uncomfortable levels which is sure to become a big topic for the elections later this year.

The number of persons employed peaked in August 2008 at 6.693.400 persons and has since declined to 6.574.500 persons for a total loss of employment of 118.900 people in April 2009. At the same time the registered number of persons in the labour force increased by 120.140 people from 7.196.110 to 7.316.250. These figures highlight one of the challenge with having a large and growing labour force in the sense that you need to maintain momentum in order to be able offer the jobs which the people rightfully demand.

Of course, a growing labour force is a good thing in itself, but in the current environment we should not rule out the case that it can become a source of "unrest" and fierce political debate. Should the employment situation continue to deteriorate on the margin (that is unemployment reaching some 15%) it will be very interesting to see how this drives the discourse in the upcoming elections.

Policy and Inflation

As noted, the last time I had Chile under the loop the central bank perceived the risks to economic stability in a wholly different light than it does now. At the time, inflation was running at some 10% on an annual basis and the central bank was busy moving up nominal interest rates. That has changed now.

Chile's central bank is formally targeting an inflation rate of 3% and just as it was running way above this target in the period leading up to the crisis, so has it plummeted accordingly and is currently running at negative values on a monthly basis. This has prompted the central bank to lower rates to an unprecedented level of 0.75% in June and most analysts expect another nudge downward come the July session (the graph to the right plots the interbank rate). If this turns out to be the case, the central bank will have lowered interest rates by 7.75 % over the course of the last 6 meetings. Just as it has been the case with other more prominent central banks, the Chilean derivative is trying to steer expectations in an environment where long term yields have begun to inch upwards to reflect the solidification of the second derivative discourse. In general, the central bank is tracking inflation closely with its target interest rate as can been in the graph to the right.

On the fiscal front Chile is in a much better position than most. Alongside the measures taken on the monetary front the government has, so far, initiated US $4 billion package of government spending and tax cuts. According to the budget office the budget deficit will amount to 4.1% of GDP this year, a position one finds it difficult to believe that Chile will have trouble financing. On June the 15th Chile's fiscal authorities announced a bond issuance worth $ 1.7 bn as well as its intent to use $4 bnfrom its offshore savings to fund spending.

Not too Shappy

All in all this does not look too bad now does it? In many ways I agree with CitiGroup's research department as they wrote in their latest overview of the Latin American economies;

We believe that the Chilean economy is one of the best positioned to capitalizefrom a global recovery. The openness of the Chilean economy made it one ofthe most vulnerable to the global slowdown, certainly after Mexico. But thestrength of its domestic fundamentals helped the economy withstand the globalshock.

Clearly, there are downside risks here and these come mainly from any adverse shocks Chile might suffer from another global fallout or simply the risk that global growth won't recover to the extent many are currently expecting. Yet, it is important to point out here that Chile's relative strength has two sides. On the one hand there is no doubt that the presence of Copper and the important of this commodity in the global value chain as well as the sound management of the windfall from this is very significant. On the other hand I have also, as per usual, emphasised demographics as a key variable and specifically that Chile is still riding the waves of the demographic dividend, or more aptly the afterburner of this process. In fact, what is important for Chile at this point is to lock in the favorable path by avoiding that fertility falls too much below replacement level. If Chile succeds in this, it may truly turn out to be an example to follow on more than one front. 

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[1] - I distinctly remember that he has been quoted for something like this, but I don't remember the exact wording. 

[2] - I use the following formula ln(t0/t-1).

[3] - If you run regressions as single linear models in turn with X1 and X2 respective as explanatory variables this pattern is repeated with almost identical R-sq values albeit somewhat higher for Copper prices.

Rather, I thought it would be interesting to have a look at one of the (relative) success stories in the midst of the economic mire in which we find ourselves. The economy in question is Chile, and apart from Bloomberg's report that Finance Minister Andres Velasco, after having been "burned" back in November, is now almost a rock start the point is well worth pondering.

(cut and paste at my discretion)

The Chilean peso has risen almost 10 percent against the dollar this year to become the best-performing currency among emerging markets. The country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund. While Chile stashed away copper profits, neighboring Argentina boosted spending when revenue from soybean exports rose, leaving it short on cash to stimulate the economy this year.

(...)

Velasco set up funds to invest the copper windfall abroad, mostly in government bonds. He announced plans to spend the interest from savings on scholarships and helped Bachelet extend social security to 1.3 million people. In his first three years in office, Velasco posted the biggest budget surpluses since the country returned to democracy in 1990. In 2007, Chile became a net creditor for the first time since independence from Spain in 1810.

Last July, copper reached a record of $4.08 a pound. By year-end, the central bank had built $23.2 billion of reserves. The government had $22.7 billion in offshore funds and about $2.8 billion in its own holdings.

After Lehman Brothers Holdings Inc.’s Sept. 15 bankruptcy sparked a global credit freeze, Velasco and De Gregorio had the equivalent of more than 30 percent of GDP available if needed to shore up Chile’s banks and defend the peso. The price of copper plummeted 52 percent from Sept. 30 to year-end, and Velasco dusted off his checkbook. In the first week of January, he and Bachelet unveiled a $4 billion package of tax cuts and subsidies. “He has been vindicated,” said Luis Oganes, head of Latin American research at JPMorgan Chase & Co. in New York, who studied under Velasco.

The story about the copper windfall in Chile is a remarkable story really and as I reported in an extensive review of the economy back in October Chile's government went into the crisis in the rare role as a net credit with debt to gdp at -11%. Moreover, I have also shown how Chile has managed to wield the benefits of the demographic windfall (the demographic dividend) rather well.

If we look at some indicative economic evidence it does indeed seem as if Chile is the odd man out in Latin America with the Peso performing somewhat better than the main benchmark (according to me) in the form of the Brazilian Real as well as the markedly lower increase in sovereign debt spread due to the crisis. 

So, I guess the question is then. Should you invest in Chile? Clearly, Chile is also like most other countries currently in a recession, but then again why not? I hold that Chile is one of the best opportunities to pick up a decent return in the context of an otherwise rather rugged emerging market edifice. But then again, I am not an investor.

[Disclosure for Seeking Alpha: No positions]

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[1] Although please do retort in the comments section. And RP, you can bugger off!

There are many perspectives through which to look at economic development and growth. Geography, institutions or perhaps just plain good old physical capital accumulation are all important parameters. This small piece suggests a further metric and attempts to frame the argument with Chile as a case study.

Specfifically, this note explains the process known as the demographic dividend and conceptualizes it in a Chilean context. The analysis shows how Chile during the last two decades has benefited from the dividend proxied by the increasingly favorable trend in overall age structure of the society. By some measures Chile’s demographic dividend is thus ending during these very years. Yet, by adapting a slightly broader definition of the optimal working age and subsequent productivity profile, it appears that Chile still finds itself in the proverbial sweet spot and will continue to do so for the next decade. Coupled with the favorable windfall from copper exports and the subsequent transformation of this into an unprecedented net wealth position of Chile’s public accounts, the economy looks on a very solid footing to face whatever travails that might come next.

Chile's growth performance depicted by the chart is interesting in so far as it shows us the period that some scholars have dubbed Chile's Golden Age (Gallego and Loayza, 2002) due to the extended period of high growth rates. Between 1984 and 1998 Chile's growth rate in output per capita averaged 5.15% a year with a volatility of 2.64% p.a. This compares with an average growth rate in output per capita between 1998 and 2008(f) of 2.61% and a subsequent volatility of 1.73%. The 1985-1998 figures are remarkable and thus deserve some explanation.

According to Gallego and Loayza (2002) Chile's impressive growth performance primarily comes down to improvements in total factor productivity induced by increased investment in human capital and the development of a sound and coherent institutional setup. As such, and not unlike other growth accounting exercises the authors initially find that TFP accounts for the biggest share of output growth alongside the usual suspects of capital accumulation and growth in the labour force, the latter which is (in)famously coined as synonomous with population growth in the neo-classical growth model

The empirical approach is rather straight forward in terms of methodology, and is closely related to the tenets of endogenous growth theory as well as of course Mankiw, Romer and Weil's (1992) seminal findings that investment in human capital be considered an important part of capital accumulation. Formally, the authors first estimate a cross-section regression framework (GMM) based on a, more or less, standard neo-classical growth model augmented with human capital (schooling rates and life expectancy). The authors also include; government consumption to GDP, financial market development, terms of trade shocks, trade openess, and a black market premium. They find that this model account for 43% of the growth observed in Chile.

Unsatisfied with this result, the authors imbue the model with a number of variables whose origin in the growth theory framework are inspired by the tenets of endogenous growth theory. These variables include proxies for the political system, governance, public services and infrastructure, and with these, the new model moves reaches a coefficient of determination of 73%.

In line with endogenous growth theory the authors consequently find that this initial "residual" best be explained by improvements in the institutional edifice of Chile's economy. As a result and although the notorious convergence effect will tend to lead to lower overall growth rates in period t0 than in period t-1, the authors suggest that Chile focus further on institutional improvements to foster growth in the future.

Far be it from me to take issue with these results. However, in the following I propose another way to look at the past and future growth performance of Chile. It is important to understand that the two approaches are not mutually exclusive but ultimately directs the attention to a different set of governing mechanisms when it comes to economic growth.

A Demographic Dividend?

In one of their many papers on the subject David E. Bloom and David Canning (see Demographic Challenges, Fiscal Sustainability and Economic Growth, PGDA Working Paper no. 8) provide a useful historical sweep of the different approaches to demographic changes and their significance on the economic edifice. From the Malthusian epoch to a more optimist view on the benefits of vibrant population dynamics (see e.g. Simon Kuznets, Julian Simon, and Ester Boserup) and on to what Bloom and Canning coin as the “neutralists” [3] , the perspective on the importance of demographics has certainly changed a lot.

One crucial lesson to draw from the historical prism of demographic discourses is that the demographic transition is a far more complicated process than a mere transition in population growth rates as well as one of sectoral shifts in the economy. Lee (2003) consequently shows how the demographic transition also fundamentally changes the age structure of society whereas others such as Malmberg and Sommerstad (2000) and Hugh (2006) have suggested that the demographic transition be re-thought all together. Common for these contributions is the shifts in age structure, the complex mechanisms which govern these changes, and their subsequent effect and operationalization on the macroeconomic edifice.

Bloom, Canning and their fellow scholars on the PGDA at Harvard, [4] have furthermore showed how age structure makes a much more solid demographic yard stick, for gauging economic trends, than merely looking at population growth and absolute size of the population. This, I think, is the ultimate lesson to derive from decades worth of thinking on demographic processes. I would essentially divide the lesson into two irrefutable points. One is that age structure matters much more than population growth and that a simple metric such as median age can give us a tremendous amount of information on an economy's given and future growth path. The second points is simply that the demographic transition is not, by a long shot, over. In fact, nobody knows when it will end.

It is within this framework that the process known as the demographic dividend enters, and not surprisingly, it is all about age structure and how economies who go through the demographic transition at some point will find themselves with above average conditions for growth as the working age as well as productive share of the population is maximized. In terms of median age and as a crude benchmark, we can say that those economies with median ages between 25-35 are situated in or close to the optimal age structure for economic growth. Nothing comes for free however, and it is crucial to point out that the demographic dividend provides an opportunity rather than a sure benefit. For example, it seems that Eastern Europe and Russia, by and large, have gone through their demographic dividends without experiencing the corresponding win-win situation in which favorable growth conditions coincides with advances in terms of institutional quality and political stability.

The demographic dividend operates through two interconnected mechanisms in the form of falling fertility and declining infant mortality. In most countries, falling mortality as the economy moves through the demographic transition has been accompanied, with a lag, by falling fertility Bloom and Canning (2006). If we add a steady increase in life expectancy to proxy the general improvement in the health of the population these interconnected processes endow an economy with a period of, let us say, 15-20 years in which the young and working cohorts of the society are relatively big compared to the dependent cohorts. The former are often defined as the cohorts aged <20-25 [5] years and for the latter's part >65. As for quantitative importance, Bloom and Canning (2004) have shown this to have a positive effect on per capita output as well as they have famously shown how one third of the East Asian Tiger economies’ impressive growth spurt in the latter part of the 20^th century can be explained by the demographic dividend.

More generally Bloom & Canning et al. (2007) have also demonstrated, through cross sectional regression data, how age structure can significantly improve the forecast of economies' growth rate relative to world GDP.

Chile’s Demographic Dividend

If large parts of East Asia have already had their demographic dividend what about Chile then. Is Chile about to receive, or more aptly; is she in the middle of her demographic dividend?

As can readily be seen, Chile almost displays a textbook case of economic development. In this way, infant mortality has fallen back sharply since the middle of the 1970s as well as life expectancy has increased. Outside the immediate realms of economics, biologists and health economists speak of the process known as the epidemiological transition to explain the progression of the change in (and drivers of) variables such as mortality, life expectancy, and other public health metrics.

The reduction of, and subsequently the current level of, infant mortality in Chile rivals that of many developed economies. According to Albala and Vio (1995) Chile managed to reduce infant mortality by 82% between 1970 and 1992 and Jimenez and Romero (2007) further shows how provisions of services to counter perinatal risks and acute respirator distress have helped Chile to reach an impressive infant mortality rate of 8.9 infants per 1000 thousands in 2000.

With respect to life expectancy Albala and Vio (1995) describe how the mortality rate of people aged 65 and more decreased 73% between 1970 and 1992 . Especially, a reduction in the mortality from cardiovascular causes is highlighted. In a more recent paper Albala, Vio et al. (2002) also latch on to increasing risk posed by a transition from a prevalence of infectious diseases to on in which chronic diseases ascend in importance. The usual suspects here would be an increase in obesity as a result of malnutrition through the consumption of high-fat/high-carbohydrate energy-dense foods and a decrease in physical activity. Chronic diseases which spring from such developments would then be e.g. type 2 diabetes and cardiovascular diseases. Evidence of this development appears in the context of school children; from 1987 to 2000 the prevalance of obesity among first grade school children rose more than 100% for both boys and girls.

Much debate has and will be devoted to the extent that such adverse developments from economic development could, at some point, break the curve in terms of life expectancy. At this point however, it seems as if advances in healt care services and the subsequent improvements in old age life expectancy are enough to keep the curve ticking upwars.

Returning to the question of demographic dividend in Chile, the trend of the decline in infant mortality exhibits the expected negative concave relationship as per function of the fact that the value cannot fall below 0. In order to build a simple model framework and by applying the logic expressed through theory above, we can construct a rudimentary econometric model to formalize the argumet.

Consequently, we let the lagged change (one year) [6] in the infant mortality rate predict the change, in year 0, of the fertility rate. Given the properties of the time series in question, and the theoretical framework above we would expect a positive but also a concave relationship since both variables are bound by the fact that they cannot fall below 0. In general terms, this model clearly assumes that the process of decline in fertility throughout the demographic transition is infinitely simpler than it really is. The crucial point here is that while the decline in infant mortality may be able to explain the decline in fertility on a certain part of the curve it cannot, and may in fact see its sign reverse, as we move further towards replacement level fertility and beyond. One could even with reasonable claim ask whether in fact the decline in fertility towards replacement levels is driven by infant mortality reductions alone. Nevertheless, the model estimated looks as follows where both variables are in changes.

Which leads to the following estimation:

The visual inspection of the model can furthermore be derived from the graph below.

In general, the model is far from solid but it manages to get the message across in the sense that it links the decline in fertility to the lagged decline in infant mortality [7] . The key thing to remember is the implicit and theoretical concave relationship cited above; a relationship also confirmed by the scatter plot.

The interesting thing about Chile here is that, according to standard demographic theory, the demographic transition should, by and large, end now as fertility trends towards replacement level. Not a lot of serious scholars would believe that however and we can thus expect fertility to decline below replacement level (see e.g. Wolfgang Lutz here). The extent to which it does not, Chile would clearly constitute something of a remarkable case. This is also why policy makers would be wise to consider implementing steps to avoid fertility dropping into lowest-low territory [8] , since what we know with almost certainty is that the demographic transition does not stop once infant mortality hits near rock bottom.

This point also highlights the idea that while the demographic dividend presents a window of opportunity so does the backdrop represent a penalty. This point is crucially related to the fact that only very few economies (e.g. the US and perhaps also France) have been able to stay at, or return to, replacement levels of fertility. In most other cases, fertility seems set bound to fall further and the only real metric to gauge is the speed by which this occurs. In an emerging market context the evidence is worrying to the extent that many economies have seen their fertility rates crash completely over the course of less than a decade. The next 5-10 years in Chilean, and indeed Latin American context, will be extremely interesting to watch in this regard.

Given the fact that Chile's fertility level is already approaching replacement level, the model cited above has, in all likelihood, run its course. What will likely cause Chile's fertility rate to fall below replacement level requires an entirely different set of explanatory variables and also theoretical edifice. Key trends would for example include an elaboration of the quantum and tempo effect of fertility in a context of rapid economic development and changing social norms.

To summarize the argument in a Chilean context, the ultimate data series to gauge, in the context of the demographic dividend would be age structure and the effect from the processes described above.

As per usual, beauty is in the eye of the beholder since depending on which definition you ascribe to the optimal age structure, Chile could be said to be in and out of the demographic dividend. The truth probably is that Chile is in the twilight hours of its demographics dividend. However, with a median age of about 30 years Chile still enjoys, and will continue to do so in the immediate future, the benefits of an age structure conductive to balanced economic growth.

One important point to note here is that the 25-44 bracket peaked sometime in the middle of the 1990s. Much evidence suggests though that it is a bit untimely to make the cut at the 44 year old age group, since many people are perhaps not far from their productive peak between 44 and 64. On the other, the peak of the 25-44 age bracket may still constitute an upper level of economic capacity if viewed as the ability and propensity to sustain housing booms, large negative external balances etc.

Conclusion

Chile still has ,and will continue to enjoy for the immediate future ,a favorable age structure for harboring economic growth and dynamism. Favorable is in this context defined through the spectrum of the demographic dividend and the subsequent increase in, and high proportion of, working age people to total population. Depending on fall in fertility, the demographic dividend is definitely tapering off at this point. If experience from East Asia is anything to go by Chile as well as its Latin American peers are now set to enter a new phase of the the demographic transition in which fertility steadily moves below and beyond replacement levels. The speed here is crucial. If it happens slowly, Chile can expect to posses a relatively balanced age structure in the decades to come but if the decline is swift and lingering the effect could be otherwise.

This small piece has also touched upon the way we conceptualize economic growth and development. I would not want to discount methods such as the one deployed in Gallego and Loayza (2002). However, I have suggested that a different perspective is a also considered. I would, in particular, emphasise this in the context of the future drivers of economic growth. Nobody can disagree with the impetus to move forward on strong institutional settings. Yet, economic development is not only accompanied by a demographic dividend but also, arguably, a demographic penalty which occurs as the effect of the dividend recedes and the decline in fertility continues. This would be where concepts such as the quantum and tempo effect of fertility comes in. it is also where policy makers would be wise to consider that a relentless strive to reach the apex of the value chain will also bring with it a deficit in terms of the proper quantity/quality mix of human capital.

List of References

[1] Although Chile did not recover from the Asian currency crisis to pre 1997 levels.

[2] Bloom & Canning (2006) – Demographic Challenges, Fiscal Sustainability and Economic Growth, PGDA Working Paper no. 8.

[3] Basically, this would be the modern institutional paradigm that has emerged within the economic growth/development discourse (see e.g. Daron Acemoglu, Dani Rodrik and Amartya Sen).

[4] See numerous contributions here: http://www.hsph.harvard.edu/pgda/working.htm

[5] I would argue that this is the right threshold (unlike the <15>

[6] The time series are in changes to correct for non- stationarity. As for the lag, the optimal number of lags could be more rigorously verified on the basis of theory and the statistical properties of the time series in question (VAR)

[7] Although, as can also be observed in the graphs, it cannot predict sudden reversals in fertility trends; i.e. these would essentially be treated as exogenous shocks to this model.

"Given the data since the previous meeting, the council considered that the most plausible options on this occasion were to raise the rate by 25 or 50 basis points"

``The other day an investor remarked that when the tide goes out you see who's got their swimming suit on properly,'' Velasco said. ``I have no doubt that in this low tide, Chile will be seen to be very well-prepared and very well-dressed for whatever comes,'' The Fed's cut ``will contribute to the return of calm,'' the finance minister said, ``But there are no magic solutions. The world is living through, and will probably keep living through, a period of international volatility. We have to be very calm and very alert. In previous years we've saved, we've reduced debt, we've had a surplus, we've strengthened public and private finances,'' Velasco said. ``Sometimes people asked why we were doing all this, well now we see the answer and we see it very clearly.''