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Privatizing Social Security in Latin America
January 1999
Evaluating the Reforms
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"In general, nations other than Chile have committed one or more of four major errors that hinder reform."
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Are the modifications to the Chilean model introduced by other nations minor adjustments that preserve the benefits of the system, or do they change the foundation of Chile's successful experience? In general, the other nations have committed one or more of four major errors that hinder reform.
Error: Retaining Access to the Old Pay-As-You-Go System.
Although permitting workers to choose between remaining in the old system or moving into a new system has some advantages - including freedom of choice - it is a mistake to allow workers entering the labor force for the first time to join a system that is doomed to bankruptcy. By keeping both systems in place, the new retirement program, capitalized by individual retirement accounts, ends up paying at least part of the cost of the old system. This error is particularly manifest in Argentina's and Colombia's reforms. Chile, Bolivia, Mexico and El Salvador, on the other hand, have made clean breaks with their old programs.It is important to note that some of the countries, especially Peru and Argentina, are having difficulty maintaining their pay-as-you-go systems because so many workers have opted out.
Error: Taxing the New System. When Peru introduced reform, it loaded the new program with taxes that made it more expensive than the program it was intended to replace. This mistake cost the Peruvian government two years, during which the incentives encouraged people to stay in the old system.
Error: Creating a State-Run AFP. This is a mistake because, as in Argentina and Uruguay, "official" institutions always have unfair advantages in the competition with private companies for both customers and retirement funds. Many Latin Americans remain enamored of state-run companies; this fact encourages politicians to incorporate state-run AFPs in their reform plans. Even in Chile, the state-run Banco del Estado competes with private commercial banks.
Error: Creating a Mixed System. For those who believe the truth always lies midway between two positions, a mixed social security system is almost irresistible. The most frequent variant has the government funding a universal pension for all workers, with the private system as a supplement. Although in some cases political considerations may make a mixed system the only option, policymakers should be clear on the option's impact. Mixed systems are inefficient because the state is subsidizing the pensions of the highest- and middle-income sectors from tax revenues. Argentina's system is an example of this error, whereas in Chile, Peru and El Salvador, government resources provide minimum pensions only for the most needy.
However, the centralized collection formats used in Argentina and Mexico do not alter the underpinnings of the private pension framework and may be justified in terms of cost savings.
Conclusion
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"The Chilean system had the desired impact on savings and financial markets - and it introduced a new approach to retirement pensions.." |
When Chile instituted its fully funded retirement pension system based on individual accounts in 1981, its untested idea was driven more by the need to boost savings rates and develop domestic financial markets than by a recognition of the existing social security system's unsustainablibilty. The Chilean system had the desired impact on savings and financial markets - and it introduced a new approach to retirement pensions. Rather than taxing current workers to pay the pensions of current retirees, the new system enabled workers to save for their own retirements, receiving higher benefits than under the old system. It also eliminated the growing unfunded liability of the government under the old system.
The success of the Chilean system has resulted in its use as a model for reform in other Latin American countries and in nations around the world. Some of the Latin American nations have followed the Chilean model more closely than others, and the variations adopted in some countries contain the pitfalls described above. Still, workers in those countries have better prospects of stable, substantial retirement incomes than they had before the reforms.
Meanwhile, Chile has fine-tuned its system and continues to make changes as minor shortcomings or better operating methods are discovered. Yet the basic structure has remained intact: a system of individual, capitalized accounts funded by the workers for their own retirement.
About the Author
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Luis Larrain Arroyo
is an economist at the Universidad Catolica de Chile in Santiago and deputy director of Instituto Libertad y Desarrollo, a Chilean public policy research institute. He was an advisor to Minister Jose Piñera in 1980 when Chile was designing the world's first privatized social security system, and was Chile's superintendent of social security from 1981 to 1983. Mr. Larrain also served in the Chilean government as deputy director of Odeplan (the Planning Ministry) from 1985 to 1989 and Minister of Odeplan from 1989 to 1990.NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.