Can correcting for real exchange rate misalignment help countries escape the middle-income-trap? An analysis of a natural resource-based economy: Chile

Abstract

Chile is classified as a high-income country but suffers from the same weaknesses affecting middle-income countries. The same policies that have encouraged the dependency on natural resources and restricted the expansion of the productive and export base, have prevented the use of exchange rate policy as an instrument of economic and social development. The performance of the economy is greatly determined by the evolution of the terms-of-trade which is negatively correlated with the real exchange rate. Also, the nominal exchange rate has been used mainly as an instrument for price stability purposes rather than for economic development. Building on the exchange rate misalignment concepts developed by the New Developmentalism, the analysis shows that, at the macroeconomic level, the real exchange rate has appreciated over time. However, the evidence also shows that the industrial/manufacturing sector has an external price competitive advantage in relation to the rest of the economy. This raises the broader question as to what extent is price competitiveness a powerful enough incentive for a broad-based structural change towards innovation and more knowledge intensive production which is needed to escape the middle-income trap.