Jewish World Review Feb 17, 2005/ 8 Adar I, 5765
The Chilean plan is working... 10 minutes with WSJ editor Mary Anastasia O'Grady
Fans of Social Security privatization in the United States usually point to Chile as the best example of a successful government-created private pension system.
Started in 1981 when the government system collapsed, the system now has about 60 percent of Chilean workers contributing 10 percent of their pay (plus 2.3 percent for administrative costs and insurance) into private personal accounts managed by private companies.
To find out more about how well Chile's system works and whether it has anything to teach us about Social Security reform, I called The Wall Street Journal's Mary Anastasia O'Grady. The editor of the "Americas" column that appears Fridays, she has been watching Chile's private pension system for years.
Q: Is it true many average Chileans are unhappy with their pension system, as The New York Times recently reported?
A: Well, I haven't taken a poll, so I'm not going to make a broad statement that many Chileans are unhappy with it. I would question the reporter's ability to make that assessment I mean, is "many" more than three? I think the main measure would be to look at people who have been saving in the pension system and look at the system's rate of return, which, as The Times noted, is 10 percent annualized. That's a darn good return, and it's hard for me to believe that anybody who's planning to retire after 40 years of that kind of compounding interest could be quote-unquote "unhappy" with the system.
Q: How does Chile's system work?
A: There was a government social security system in 1981, when they realized it was unsustainable for, as the World Bank noted, the same reasons the U.S. system is unsustainable: not enough workers coming in, and too many workers at the other end. So they did not kick anybody out but said anybody joining the new system would only be saving in a private account. There's money that comes out of your paycheck those are the payroll taxes but rather than going to the government, it goes to a pension account where you choose from a select, conservative group of investments that are largely targeted at stocks and corporate and government bonds. The pension funds are highly regulated, so they're not risky investments, and there's a high degree of diversification.
Q: Is the system doing what it was intended to do?
A: Oh sure. Despite all this bad stuff that The Times said, it's producing a 10 percent return on savings. So it's behaving extremely well. The whole idea is that you have to look at it over a 40- or 50-year period. They didn't make a lot of promises. But it has fueled a lot of economic growth in Chile, and it's given Chile the fastest economic growth rate in Latin America in the last 20 years. So Chile is less poor than it used to be. It was a very poor country in 1981.
Q: What's its biggest weakness?
A: It's not really a weakness of the pension system, but the overall problem is that Chile remains a poor country. It has lower gross domestic product (GDP) per capita than even Argentina, which has been through a very big crisis. From where it came from, it's phenomenal, but it's still a poor country, which means about half of the population is not working in the formal economy and does not earn enough to really save for retirement. If you're not saving for retirement in the system, your fallback is a safety net that the government has that is better than what the government was able to provide in 1981.
Q: Is it mandatory?
A: If you are in the formal economy, it is mandatory. But if you are a housekeeper in someone's house, it is not mandatory. The reason for that, as Salvador Valdes of Catholic University in Santiago says, is that it's cruel to force somebody to live at an even lower standard of living in order to save for their old age.
Q: Can you take the money out before retirement?
A: I don't know about that. It's fairly strictly regulated. There might be hardship where you could do that, but they have discouraged that. One thing they have encouraged a lot is for people to think of it as their own money. Anybody who's in the system has a little passbook, and it's updated all the time. So that gave people a real sense of ownership.
Q: What about Chile's transition costs?
A: There is a cost of transitioning over, but the sooner you do that, the better, obviously. The cost is higher depending how long you leave the public system open. Jose Pinera (Chile's former secretary of labor and social security and fellow at the Cato Institute) insists it is very, very important that you close the old system to new participants. Lots of countries in Latin America did not do that. They continued to give the people a choice of going to the old system or the new system, and that created all sorts of distortions. It made the cost of transition more costly, and, in fact, in the case of Argentina, they never actually made it.
Q: Would something like Chile's pension system ever work in the U.S.A.?
A: Oh sure. I think it would work better because we are a richer country. There's more per capita income to allow people to save for their retirement in private accounts. I think it's actually a requirement, because there is no way that the Social Security system can work right now. No matter how much the Democrats are in denial, there is no way that you can maintain the standard of living if you don't raise the capacity for working people to save for their retirement. So that right there says you have to let people save tax-free and still have a tax-free account for their retirement, more than what Social Security is now. You can fiddle around with different ways of doing that, but I think the best way to do it is just let people be free.
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JWR contributor Bill Steigerwald is an associate editor and columnist at the Pittsburgh Tribune-Review. Comment by clicking here.
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© 2005, Bill Steigerwald