When he is stumping for his personal retirement accounts vision for Social Security reform, President Bush often points to the success of Chile, which introduced personal accounts in the early 1980s. If a poor South American nation could make the reform work, the argument runs, so could the United States.
Opponents of Bush’s reform have thus taken to attacking the Chilean reform. In a recent article in the New York Times, reporter Larry Rohter painted a bleak picture of the Chilean private pensions. He suggested that in Chile the system is widely viewed as a failure. The article strongly echoed claims made in December by Times columnist Paul Krugman. “Privatization,” Krugman argued, “would have condemned many retirees to dire poverty, and the government [has] stepped back in to save them.”
But is the situation in Chile as bad the anti-reformers suggest? And are the problems that they accurately identify likely to be duplicated in the United States? The answer to both questions is no.
Rohter notes that as “the first generation of workers to depend on the new system is beginning to retire, Chileans are finding that it is falling far short of what was originally advertised.” But it is far too early to gauge the success of the Chilean model. The retirees depicted in Rohter’s article have only been contributing to their accounts for, at most, 24 years — far short of a typical wage-earner’s career.
Rohter points out that nearly half of the Chilean workforce are independent contractors or employed in off-the-books jobs. Neither group is required (and many are unable) to contribute to pension plans. Many of those now retiring — those whom Rohter identifies as examples of the system’s failure — are at a disadvantage with their personal accounts because they have been contributing to a pension system only since the reforms were passed in 1981, rather than over their entire working lives.
Since they were not part of the formal economy before the reforms, these retirees are dependent solely on the returns of their 24 or fewer years of contributions to their personal accounts.
Dealing with workers who were previously uncovered by government-funded pensions won’t be nearly as large a problem in the United States. With the near-universal coverage of Social Security, everyone who has ever paid FICA taxes could be issued a recognition bond for contributions to the old system.
Several of the leading reform bills include recognition bonds. If the bonds are part of a reform package, workers who are in their mid-40s at the time of reform wouldn’t be dependent on only 20-plus years worth of contributions when they retire.
IN DECEMBER, PAUL KRUGMAN criticized Chile’s system for its excessive “management fees,” which he estimated at 20 percent. Rohter echoed this concern, noting that accounts are “burdened with hidden fees that may have soaked up as much as a third of their original investment.”
But Krugman and Rohter embarrassingly failed to mention that those figures include the cost of life and disability insurance. According to Rodrigo Alamos of Capital Advisors in Chile, the two writers misled readers about the high fees.
“You only pay when contributing money to the system,” says Alamos. “After your money is in the system you never pay again. If you compute these up-front charges and convert them to an annual basis over AUM [assets under management], the resulting figure is 0.7-0.8 percent annually.”
Chilean economist Salvador Valdes-Prieto agrees with Alamos, noting that he has calculated the fees at .65 percent of managed assets — note the decimal point —, which is lower than fees generated by the average mutual fund in the United States.
These fees could be even lower in an American personal accounts reform. As Donald Luskin pointed out recently, “It’s laughable for a professional economist like Krugman to suggest that fees charged by the tiny, over-regulated Chilean financial services industry would in any way represent the best we can do in the United States. Here, large, highly developed, competitive, and relatively unregulated markets create enormous economies of scale.”
Rohter’s reporting reinforces this point. He noted that over-regulation has stifled competition in the Chilean financial industry, keeping fees higher than they need to be. Guillermo Larrain, director of the Superintendency of Pension Funds, was quoted as saying, “The dynamic of the market is one of consolidation and concentration.”
Unfortunately, Rohter failed to point out that the conditions that create consolidation and concentration — extreme over-regulation and little competition in financial services — simply don’t exist in the United States.
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