Potential output growth in emerging market countries : the case of Chile

Two issues related to emerging market countries have recurred in recent years. The first is whether their past high rates of growth are sustainable in the medium run, and the second is whether these rates could lead to overheating pressures. Although most of the discussion has concentrated on the rapidly growing East Asian economies, the same concerns have arisen about Chile. Using a combination of growth accounting and regression analysis, this paper studies both issues for Chile during 1970-96. During the last decade, the indices of capital and labor quality show a steady growth pattern, as the share of equipment in total capital rose and higher-skilled jobs were created. In 1986-90, the quality-adjusted labor variable explains close to 60 percent of Chile.s growth rate of GDP, while during 1991-95 capital formation plays a dominant role. The contribution of total factor productivity (TFP) growth is relatively small, is estimated to increase in the medium term and to help sustain Chile.s high GDP growth rates. Total GDP is found to cointegrate with quality-adjusted capital and labor after a break in the deterministic trend that captures technological progress is taken into consideration. This break is confirmed by the estimation of Solow residuals, which begin to trend upward around 1985. The existence of constant returns to scale could not be rejected, and the share of imported capital goods in total capital appears to be one of the factors behind TFP growth. To estimate potential output, the cyclical component of TFP and employment was removed using the Hodrick-Prescott filter. For Chile, this procedure captures a possible increase in the natural rate of unemployment in the late 1970s.related to structural reforms.as well as a relatively large trend component in labor force participation. The estimates show a positive output gap in the years when the economy was deemed to be overheated, leading the central bank to tighten monetary policy. However, the paper did not find the positive association between output gaps and inflation typically found in industrial countries and more recently in several Asian countries.