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.
THE RETURNS ON INVESTMENT in the Chilean system have been
phenomenal so far, averaging 10 percent annually. Rather than focus
on this, the reporter found Dagoberto Saez, a cherry-picked sob
story who is retiring after 24 years in the new system with a
monthly pension of $315 per month. Rohter reported that Saez’s
colleagues, who remained in the old system, get over twice what
Saez receives.
Though Rother picked Mr. Saez as an example of all that is wrong
with the Chilean system, he should have thought about his choice
more carefully. Having contributed for 24 years, Saez now receives
one-third of his pre-retirement income from his personal
account.
That is a replacement rate of 33 percent of Saez’s last
wage, not his average career wage, to which benefits in the
U.S. system are tied. Had he been able to contribute to a personal
account over his entire working career, he very likely would have
far surpassed his colleagues who remained in the old system. It’s
worth noting that the large pensions his colleagues are on an
unsustainable track — that’s why Chile
switched to the personal accounts system in the first place.
Rohter’s reportage does raise legitimate concerns about the
Chilean economy. But those issues were both exaggerated and
unfairly laid at the feet of the nation’s system of personal
accounts.
To start, the “billions” of dollars that Rohter said had been
paid out by the government to fund retirements were billions of
Chilean dollars, not U.S. greenbacks. According to Estelle James,
former lead economist of the world bank, the annual cost should be
stated in millions of dollars for American readers.
These debts should not be charged against the personal accounts
system. The payouts from the government to old folks who didn’t
take advantage of the personal accounts are, in fact, a direct
subsidy from taxpayers. As the results become more fully known, it
is very likely that the personal accounts will make this problem
less severe, by reducing overall welfare spending as Chileans are
allowed to build inheritable wealth that they can pass on to their
families.
Those who have remained in the old system have indeed extracted
$60 billion Chilean dollars from public coffers since 1981. But as
they pass on and are replaced by a new generation of workers who
have opted for their own personal accounts, the public subsidy
should fall sharply.
It’s hard to see why anyone would call Chile’s personal accounts
system a failure. Removing barriers to legal employment and
fostering a competitive environment among personal accounts
managers could certainly help the system operate more effectively,
but they are not problems with the system itself.
With rates of return that are more than double what was
originally projected and Chile’s economy booming, it’s a shame that
the United States didn’t follow suit when it reformed Social
Security in 1983.
