Income Convergence, Capability Divergence, and the Middle Income Trap: An Analysis of the Case of Chile

The adoption of a free market model in the early 1970s reinforced Chile??s specialization in natural resources, particularly in mining. At the same time, it set the stage for successful diversification within natural resources creating pockets of excellence. This resulted from a combination of foreign direct investment (FDI) spillovers, technology and knowledge transfer, adequate firm capabilities, and strategic government intervention. During the 1990s, the country witnessed solid growth and income convergence with the developed world, followed thereafter by a deteriorating performance. This reflected a growth-reducing structural change visible in the limited capacity of the natural resource industries to generate broad-based upgrading. Recent government initiatives have placed the focus on vertical industrial policy fostering innovation and knowledge. These efforts are limited by low levels of research and development (R&D) expenditure, a lack of an innovation culture in the private sector and overall low social capabilities. The stagnation of Chile at middle income levels remains a distinct possibility unless concerted efforts are undertaken to promote broad-based upgrading.