Chile’s rationale for eliminating public pay-as-you-go programs (like Social Security in the United States) and sending workers into a private system of individual accounts was twofold: first, private funds would increase further and s ‘accumulate faster through better management, which means more money for retirement; second, the change would reduce public spending.
Four decades later, the Chilean system has not worked as promised or expected. The creators predicted that the average worker would save enough to earn 70% of their salary in retirement; the reality was closer to a third. They believed the new system would increase the number of workers with retirement funds; instead, nearly 40% of Chileans have nothing to fall back on. Rather than improving the lives of Chile’s elderly, most retirees are living on less than minimum wage, with women harder hit than men.
The private system also did not let the government off the hook financially. The transition period was always going to be expensive, as the government footed the bill for those retiring at state expense without collecting payroll taxes (as these contributions were all directed to private accounts). But the government also had to support many more pensioners from the new system than expected. Officials believed that less than 10% of wage earners would rely on public largesse for a minimum pension. Today, more than 40% need government intervention.
The biggest beneficiary turned out to be Chile’s capital markets. Pension fund managers have invested tens of billions of dollars accumulated in individual accounts in local stocks and bonds, broadening and deepening these markets. This has helped domestic and international investors, as well as large corporations. It has done less, at least directly, for savers.
Why did the Chilean experiment fail? Low private payments to retirees partly reflect low contributions. Unlike the United States, Europe and elsewhere, employers were not required to contribute. This was left to the employees. At 10% of their salaries, the income is often not enough to retire, even after accumulating for years. Small sums inside mean small sums outside.
Add to that the years when many workers do not contribute at all. With 1 in 4 jobs in Chile cut, many workers, at some or more points in their economically active life, will not contribute. The self-employed could also choose whether or not to join, and many did not. Sporadic contributions have also reduced the retirement nest egg.
And particularly in the early years of the program, excessive fees reduced the initial pot that could grow over workers’ lifetimes. Chilean pension funds charge flows, not assets. Many funds initially charged 25 or even 30 pesos out of 100 (rather than, say, 1 peso per year for 25 to 30 years). Commissions have gone down a lot since then. Yet many charge 10% or more of initial payroll deposits as fees. In contrast, administrative costs for US Social Security are less than 2% (partly because there are no marketing costs). With fewer pesos invested and accumulated over time, the less wealthy have struggled to accumulate enough for a decent pension, even with good returns.
Which brings us to the biggest drawback of private social security accounts: they do not, and indeed cannot, pool risk among the population. Social insurance originated with European trade unions and mutual aid societies in the 19th century, with workers and participants helping to support their own retirees. While mutual funds have benefited the poorest or most unlucky among them the most, the wealthiest have voluntarily contributed more than they received back for the peace of mind that, if their fortunes were to deteriorate, they too would depend on these excess contributions from the wealthy. well-to-do in the group. Public social security systems do this nationwide, pooling risk among workers across industries and redistributing funds among all those who have retired (and met the minimum requirements).
Private accounts, on the other hand, spread the risk only over the lifetime of a particular individual. You save on your years of work to finance your years without work. High earners contribute more and get more, while minimum wage earners are often unable to save enough to avoid shortages.
Ultimately, privately run systems cannot help those who need more support in their later years. The pooling of risks across the working population as a whole is greater in more unequal economies and societies, because income disparities are greater and more substantial.
Previous governments in Chile have attempted to address these issues. In 2008, the government of Michelle Bachelet created public pensions for those whose savings were not sufficient for a minimum pension, as well as those outside the private system, expanding to nearly 6 in 10 earners. By 2021 , President Sebastian Pinera, whose brother was one of the designers of the private system, further expanded the public component to cover the poorest 80% of retirees.
The new president and the congress of Chile seek to go further. President Gabriel Boric will introduce a bill in August to raise the minimum pension by just under US$200 to match the Chilean minimum wage of around US$300 a month and make it accessible to all retirees. It would put an end to the current private system by making a public pay-as-you-go system the main pillar of social security. Private accounts would be relegated to a 401K plus style option for voluntary retirement contributions.
But reforming the pension system is more difficult and more costly today because Chileans are already quite old: there are only four workers for every retiree. This ratio is expected to deteriorate in coming years, surpassing that of the United States by 2050. Boric wants employers to contribute as well, increasing the amount of money set aside to fund retirement. It also proposes specific non-wage taxes to guarantee pensions and other social policies, including new mining royalties and a possible wealth tax.
Pensions have never been adapted to strictly private management, because the basic elements of the welfare state are definitive public goods. Yet the system’s failure has reverberated beyond retirees trying to make ends meet. Pensions have become one of the main causes for millions of Chileans who took to the streets to protest in 2019, pushing for the formation of a Constituent Assembly to draft a new Constitution to be voted on in September.
The best path for pensions would be a reform that ensures adequate pensions for more Chileans. This requires a more robust public system with dedicated funding to support it. If lawmakers can make this happen, they can reduce the financial hardship that too many Chilean seniors currently face. And, to the benefit of democracy both in Chile and among its neighbours, they could thus restore at least part of the political legitimacy that the old system helped to cast doubt on.
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Shannon O’Neil is a Bloomberg Opinion columnist. She is Senior Fellow for Latin American Studies at the Council on Foreign Relations and author of the upcoming “The Globalization Myth: Why Regions Matter.”
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