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Nicole Ellis
June 2, 2015
Political Science 154B
Prof. Geddes, TA: Manoel DIS: 1D
UID: 104-501-234
Effects of Free Trade Agreements under Trade Liberalization in Chile
Over the past two decades Chile has ratified trade agreements with over sixty countries,
about a fourth of which are free trade agreements (“Acuerdos Comerciales.” 2015.
www.direcon.gob.cl/acuerdos-comerciales). Throughout this paper I will seek to explain the
benefits and consequences of trade liberalization, specifically of free trade agreements, within
Chile. I intend to accomplish this by giving a very brief history of how liberalization came about
in the country. This will be followed by an outline of a strategy that Chile has pursued to foster
trade liberalization. Then, I will discuss the effects of abolishing the old price bands in order to
be able to completely liberalize their trade sector. Next, I will discuss the neoclassical and
structuralist theories that were used to predict the outcomes of the introduction of free trade
agreements (FTAs) to the Chilean economy. Then, I will explain how the use of Chile’s natural
resources and the adoption of manufacturing techniques in this sector have fostered the growth of
the Chilean gross domestic product (GDP) and provided benefits to low-skilled workers. Finally,
I will explain how this increase in GDP has led to the narrowing of the poverty gap, but has,
unfortunately, increased wage inequality within the country. Through analyzing all of these
competing influences, I will conclude that trade liberalization and the use of FTAs have been
overall good for the Chilean low-skilled agricultural working class.
The old Import Substitution Industrialization (ISI) policies began to cause severe
economic problems in Chile, as they did not foster the industrialization that had been promised.
A military coup overthrew the leftist government who, under President Allende, had been

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overseeing the ISI policies. The coup put into place the military’s General Pinochet, who became
the bureaucratic authoritarian leader of Chile for the next 17 years. Pinochet had the challenge of
fixing the downtrodden Chilean economy, which he did through the process of liberalization
beginning in 1973. One form that this liberalization effort took was through the enactment of
various trade agreements, specifically FTAs. Chile’s first ratified FTA, post- re-democratization,
was in 1997 with Canada; and they have since entered into thirteen more FTAs with various
countries both individually and in groups (“Acuerdos Comerciales.” 2015.
www.direcon.gob.cl/acuerdos-comerciales). Chile also has a variety of preferential and
economic complementation trade agreements with several more countries, proving its
commitment to trade liberalization.
In the midst of Chile’s pursuit of FTAs, the country has also embarked on a strategy of
“additive regionalism”, which is described as a process of “sequentially negotiating bilateral free
trade agreements with all significant trading partners” (Harrison et al. 2002, 49). Chile has FTAs
with three of its top trade partners: the United States, China, and South Korea (“Chile Trade
Summary 2013.” 2013. wits.worldbank.org/CountryProfile/Country/CHL/Year/2013). It is clear
that Chile is making moves to widen its market access. The strategy of additive regionalism
serves to not only lower the effective average tariff in Chile, but also to reduce trade diversion
costs (Harrison et al. 2002, 50). It is these costs that have a large influence on the welfare effects
of an agreement. Scholars have found that Chile’s goal of combining FTAs with several different
regions, including agreements with the North American Free Trade Agreement (NAFTA),
Mercado Común del Sur (MERCOSUR), and the European Union, would produce higher
welfare gains for the country (Harrison et al. 2002, 51). It is these successful welfare gains that
would allow Chileans to reap the benefits of FTAs. It was predicted that under NAFTA, the iron

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and steel, transportation equipment, milk, non-grain crops, and textile sectors would expand by
more than 10 percent (Harrison et al. 2002, 66). It would be expected that the growth in each of
these sectors would be passed down to the Chilean public through a trickle-down effect.
Another part of trade liberalization in Chile, which happened to be a caveat of the U.S.-
Chile FTA, was the abolition of Chilean price bands (Leight 2008, 226). These price bands had
been in effect since 1983 to protect the domestic production of traditional agricultural crops,
most importantly wheat (Leight 2008, 226). When the abolition of the price bands was
announced, there was a lot of political backlash from Chilean agricultural interest groups as they
reminded the government that they had a responsibility to support the poor and disadvantaged
(Leight 2008, 227). The effects of the elimination of the price bands would be felt by the small
producers and would threaten the promise of growth and equality that had been made to them by
the government (Leight 2008, 231). The price bands were to be phased out over a five-year
period with their complete abolition in 2014, as the government also reassured Chilean producers
that the price bands no longer held the importance they once did (Leight 2008, 232). Those in
opposition to the abolition of price bands and the signing of a FTA with the United States
believed that the government had abandoned the working class and the small producers’ need for
subsistence and had, instead, placed importance on the private sector’s desire to make a profit
(Leight 2008, 235). Many Chilean officials, who opposed the FTA with the U.S., continued to
argue that it would increase income inequality and that the traditional agriculture sector would be
the most threatened by the agreement (Leight 2008, 242). Despite the fears of the opposition, the
FTA with the U.S. was ratified in 2004 (“Acuerdos Comerciales.” 2015.
www.direcon.gob.cl/acuerdos-comerciales). These fears were never fully realized, as some
sectors and low-skilled workers did benefit from the FTA.

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There were two main schools of thought predicting the outcomes of trade liberalization
and FTAs in Chile. One was the neoclassical trade theory, which brought a different perspective
from those who had opposed the abolition of price bands. This theory fundamentally states that
greater trade should lead to higher employment and, if or when demand for labor exceeds supply,
potentially higher wages as well (Schurman 2001, 6). This theory, coupled with Chile’s
comparative advantage in natural resource-intensive exports, was expected to foster economic
growth within the country (Schurman 2001, 6). However, the opposing structuralist school of
thought believed that leading with Chile’s comparative advantage in natural resource-intensive
exports would not contribute to the desired economic development, believing this to be an
inferior path toward growth (Schurman 2001, 8). As it turned out, some important sectors of
Chile’s natural resources and agriculture were able to adapt in a way that allowed them to
flourish and compete under the FTAs.
In particular, the sectors of fruit, forestry, and fishing have industrialized as these natural
resource-intensive commodities started to be “virtually manufactured” (Schurman 2001, 8). An
example of such an industry can be seen with the fish and shellfish that are now cultivated using
sophisticated aquaculture techniques, which are subsequently processed and exported (Schurman
2001, 8-9). As the export sectors grew, wages and working conditions also saw improvement,
which can all be attributed to the new economic environment. This new economic environment,
in turn, created a domino effect of growth in various linked areas of the economy (Schurman
2001, 17). Over time, a natural resource-based export production complex formed between
primary, secondary, and tertiary industries providing needed raw materials, processing, and
goods and services, respectively (Schurman 2001, 17). It is clear that economic growth in these

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export sectors have spilled over and created multiplier effects in the rest of the economy as
multiple related businesses have developed to aid an exporting firm.
During the mid- to late 1990s, when Chile had begun negotiating various FTAs, many
benefits from the previous two decades of liberalization began to take shape. Chile experienced a
growth in its GDP of agriculture and forestry in the nineties, as well as in agricultural
employment; however, these had begun to decrease as the decade came to a close (David et al.
1684-1685). Winners and losers began to emerge from trade liberalization. There had been a
reduction in small farms and increased marginalization of small business as the focus for
economic growth shifted internationally (David et al. 2000, 1685). The growth in agricultural
sector employment was mainly due to the creation of temporary and seasonal employment;
which, consequently, left workers without employment in the off season (David et al. 2000,
1685). Despite these challenges, the new economic growth helped reduce rural poverty from
45% to 26% between 1987 and 1997 (David et al. 2000, 1685). Trade liberalization and the
growing list of FTAs that had been enacted during this time had begun to significantly close the
poverty gap that had plagued Chile for much of its recent history.
Since FTAs have taken effect and essentially became a part of Chile’s late 1990s
liberalization strategy, there has been a steady increase in GDP per capita and the trade
percentage of GDP; although this growth did drop when the recession of 2008 hit (Kras 2012,
14). It is clear that FTAs have served their purpose of stimulating growth in the Chilean
economy during this period. However, Chile has continued to struggle with inequality, like many
other countries throughout the world. This persisting inequality can be attributed to the increase
in demand for skilled workers (Kras 2012, 15). While demand for skilled workers has increased,
their wages have not increased as significantly. However, statistics show that low-skill wages

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have increased somewhat during this period under FTAs, and this has slowly begun to lessen the
gap between low-skill and high-skill wages (Kras 2012, 18). These changes in income
demonstrate a pro-poor aspect to Chile’s growth, as they are in favor of the poor low-skilled
population (Kras 2012, 26). As a result, it can be concluded that trade liberalization has had a
“positive and significant” effect on wages for low-skilled laborers and the population as a whole
(Kras 2012, 25). The poor low-skilled agricultural sector has benefitted from the economic gains
of the FTAs in the first several years of their implementation.
Chile, like many other countries, experienced economic woes as a result of the 2008
recession in the U.S.; however, an analysis has shown that Chile was able to weather the
recession as a result of the concurrent commodity boom (Pellandra 2015, 1). In fact, 80% of
Chile’s export revenue is made up of just four commodities which are copper, fruit, fish, and
wood (Pellandra 2015, 9). Not surprisingly, the regions of Chile, where these natural resources
are located, have benefited the most from the increased growth. Similarly, the average wage
increased the most in these local labor markets, where the benefits were mainly passed along in
the form of unskilled workers’ wages (Pellandra 2015, 3). Much of this increased growth is
credited to the importance of copper to the current Chilean economy as a whole; it makes up
about 13% of Chile’s GDP (Pellandra 2015, 10). The copper industry is also responsible for
employing up to 40% of the people in certain micro-regions of Chile (Pellandra 2015, 10). These
regional economic successes attract job seekers from the surrounding areas who are looking for
employment and higher wages. All of this results in a larger and larger employed class who are
receiving higher wages, who, subsequently, contribute to the increase in consumption and
investment in their respective local economies (Pellandra 2015, 27). This commodity boom has
led directly to a decrease in poverty nationally with even greater effects in the regions that were

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exposed to the upward price shocks of the commodity boom (Pellandra 2015, 29). However,
analyses have shown that inequality has not improved, but rather increased, although more than
ever it has a geographically uneven pattern, which reflects the positive economic gains of these
exporting regions (Pellandra 2015, 30). Other studies may explain why wage inequality has
persisted in Chile despite the regional economic growth.
Increases in wage inequality in Chile may be a result of FTAs which have increased
Chilean exports. Analysts have determined that export industries generally require higher skilled
workers as they are dealing with more advanced technologies (Pellandra 2013, 5). Exporting
firms must stay up to date on these technologies, as they are generally exporting to high-income
destinations, such as the U.S., which demand better quality products (Pellandra 2013, 6). These
better quality products, in turn, require high skill labor. Higher skilled labor demands higher
wages than the average low-skilled worker. Findings support this, with reports indicating that
exporting has, on average, a 10% positive effect on high skill wages (Pellandra 2013, 1).
However, it was also found that when a firm begins exporting, their employment of low-skilled
workers increases by about 12%, but this does not significantly affect their individual wages
(Pellandra 2013, 1). There is an understandable demand for high-skilled labor in a growing
export industry, offering better wages for those who acquire these skills. However, the export
industries have also created jobs for low-skilled workers despite the large wage-gap between the
two groups. Findings suggest that often wage inequality is more significant within a firm than it
is between different firms (Pellandra 2013, 18). As the technology used by exporting firms
continues to advance, the disparity between workers in a single firm may be attributed to a lack
of accessible education for the low-skilled agricultural classes.

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After analyzing the goals of FTAs and trade liberalization, compared to the protection
that was forfeited with the abolition of the price bands, I feel very confident in concluding that
the Chilean economy and its GDP have indeed benefitted from liberalizations. It is clear that
Chile’s strategy of producing natural resource-intensive exports in an industrialized fashion has
stimulated the economy and, specifically, benefitted the country’s regional economies. I have
become convinced that an increase in trade due to liberalization and, specifically, exports has
contributed to an overall reduction in Chile’s poverty gap. The narrowing of this gap is largely
due to increased low-skilled employment in the agricultural export sector. However, the export
industry has also created the need for many new high-skilled workers. This has contributed to a
persisting wage inequality in several regions. This analysis leads to the choice between the
negative FTA effects of wage inequality and the positive effects which have begun to close the
poverty gap in Chile. I believe that trade liberalization and FTAs have overall been very
beneficial for Chile and have improved the lives of many low-skilled workers. Further research
on FTAs in Chile may focus on the import sector and what benefits or consequences that buying
imported goods may create for average Chilean citizens.

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Works Cited
“Acuerdos Comerciales.” Dirección General de Relaciones Económicas Internacionales
(DIRECON). 2015. http://www.direcon.gob.cl/acuerdos-comerciales/#tabs-1.
“Chile Trade Summary 2013.” World Integrated Trade Solution (WITS). 2013.
http://wits.worldbank.org/CountryProfile/Country/CHL/Year/2013/Summarytext.
David, M. Beatriz De A., Martine Dir Ven and Frank Vogelgesang. 2000. “The Impact of the
New Economic Model on Latin America’s Agriculture.” World Development 28: 1673-
1688.
Harrison, Glenn W., Thomas F. Rutherford and David G. Tarr. 2002. “Trade Policy Options for
Chile: The Importance of Market Access.” The World Bank Economic Review 16: 49-76.
Kras, Alain. 2012. “The Impact of Trade Liberalization on Wage Inequality: Evidence from
Chile.” Erasmus University Rotterdam, School of Economics: 1-30.
Leight, Jessica. 2008. “The Political Dynamics of Agricultural Liberalization in the US-Chile
Free Trade Agreement.” Journal of Latin American Studies 40: 225-249.
Pellandra, Andrea. 2013. “Firms’ Exporting, Employment and Wages: Evidence from Chile.”
IZA.org :1-63.
Pellandra, Andrea. 2015. “The Commodity Price Boom and Regional Workers in Chile: A
Natural resource Blessing?” Research Institute for Development, Growth, and
Economics: 1-84.
Schurman, Rachel A. 2001. “Uncertain Gains: Labor in Chile’s New Export Sectors.” Latin
American Research Review 36: 3-29.