Labor Taxes, Employment and Growth: Chile 1998-2001

The per capita growth rate of Chile from 1984 to 1997 was among the highest in the world. During the last three years however, per capita growth dropped significantly. This paper discusses the role of factor accumulation and factor productivity growth within a simple neoclassical growth model framework to explain the evolution of output in Chile for the past 20 years, including the decline in the rate of growth. In contrast to the experience of the 1980s and early 1990s, in the last three years the driving force has not been total factor productivity growth (or the lack thereof), but a severe fall in employment. This fall, in turn, could be due to a higher hiring cost of labor associated with a labor code reform, which was debated during the 1999-2001 period. Using a calibrated dynamic general equilibrium model we conclude that a 6.75% tax on labor hiring replicates the observed fall in employment.