NCPA - National Center for Policy Analysis


October 26, 2004

Starting with Chile in 1981, several Latin American countries, including Peru, Argentina and Mexico have shifted decisively away from pay-as-you-go (PAYG) pension systems -- paying for pensions out of current taxes -- toward a self-funding system similar to what President Bush is proposing for the United States. Under these reforms, individuals are encouraged (or required) to save some of their wages in accounts that are invested in stocks and/or bonds.

The World Bank analyzes the results of the shift, noting that there have been many benefits to these developing countries:

  • Future generations will no longer be saddled with oppressive pension commitments.
  • Real returns in the new pension funds have generally been impressive.
  • Reform has galvanized the development of capital markets and helped to modernize the financial system, both by improving the quality of regulation and by generating services such as risk rating.
  • In Chile, pension accounts seem to have imparted a modest boost to economic growth by improving both capital and labor markets.

However, most people do not participate in the pension schemes. The study notes that in most countries that have adopted these reforms, only about 20 percent of the labor force participates. Why are so few covered?

  • Excessive charges by account managers have been a persistent complaint -- especially the first set of workers who shoulder the start-up costs.
  • In some countries, some of these "private" pension funds have been required to invest heavily in government bonds, and severe restrictions have been put on investments in foreign securities; as a result, returns to pensioners are low.
  • In Argentina, pensioners suffered big pension losses when the government defaulted on its debts.

Most importantly, say the authors, the pension reforms require too much mandatory savings. The typical rate has been set at 10 percent of salary. With high charges on top, this is a lot to ask poor and young workers to put aside, especially when they are bringing up children.

Source: "An oversold pension policy," Economist, September 25, 2004; based upon: Indermit Gill, Truman Packard, and Juan Yermo, "Keeping the Promise of Social Security in Latin America," World Bank, Stanford University Press, October 2004.

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