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Chilean Model of Social Security

America: Take Notes.

The country of Chile has proven that through individual choice and privatization of public programs that economic freedom is achieved. The revolutionary privatization of Social Security in Chile has bulldozed big government and has allowed the economy and individual freedom to flourish. This country serves as a perfect model for America to look to.

Chile transitioned from an unsustainable public pensions program to an incredibly successful private program by ushering new workers into it. The new system is based on individual decision making. Entering into the work force, workers were given a private pension fund that requires them to contribute 10 to 20 percent of their income. The amount put into the fund depends on the age the employee wants to retire.

At retirement, the private fund is transferred into an annuity with an insurance company. The individual is given the choice to decide what insurance company to work with and what plan best fits the circumstances. If the individual is not satisfied with the company or plan, they have the freedom to change companies. This also allows competition between insurance companies, which would lead to better service and greater returns over time.

Chile set up transitional rules for insurance companies to ensure safety. Due to the radical nature of the privatization, the government wanted to direct companies into safe investment agreements in order to prevent the loss of large sums of money. Risky investments increase the chances of system failure. “If the system had failed in the first years, we would never have been able to try it again,” said Jose Pinera, Chile’s minister of labor. However, these rules provided the roots for a continual, successful retirement system. As insurance companies continue to grow more secure, they will have more freedom to broaden investment.

For those who were already paying into the public system, they were given a choice to stay public or to enter the private system. The major cost created by the transition is the money Chile loses from the people switching to the private system. The cost was financed by the selling of state-owned enterprises that would provide for those who stayed on the public pension system. Due to the success of the privatization, around 93 percent Chilean workers switched to the new program. The public pension program will be completely eliminated the day the last person in the system passes away.

The system has had immensely positive effects:

• It generated surpluses without raising taxes, inflation, or interest rates
• Old-age pensions are 40-50 percent higher than the public pension system
• Disability and survivor pensions are 70-100 percent higher than the public pension system
• Significant decreases in the payroll tax have contributed to an unemployment rate below 5%
• Savings rates have sky rocketed and have deepened investment
• Growth rates have more than doubled in the past 10 years

At a critical time when America’s debt is upwards of $14.7 trillion and unfunded future liabilities are more than triple that number, isn’t this is the kind of growth and freedom we deserve?

Freedom Fails

But while the reform's supporters argue it has been a major success story, officials both inside and outside Chile now increasingly question whether the high costs and modest investment returns have doomed Piñera's original promise: a decent retirement income for workers at a savings for the government. Last year, the World Bank published a highly skeptical report on private retirement systems in Latin America.

Truman Packard, one of the report's authors, says the bank has told the Chilean government that it must spend more to subsidize the private system and "increase its role in preventing old-age poverty."

The bank found that exorbitant fees and other costs charged by private pension fund managers eat up as much as 15 percent of the contributions made by average Chilean workers, and even more for poorer workers. Investment returns have been far more modest than the hefty 11 percent return claimed by the private managers. The Chilean government's pension superintendent says actual returns for someone earning Chile's minimum wage were only 3.7 percent between 1994 and 2000.

A recent report by the Chilean government brought more grim news, forecasting that as many as half of all workers won't be able to save enough to receive the minimum pension when they retire—even after paying into their accounts for 30 years—and will therefore rely on government subsidies. More than 17 percent of Chile's retirees now continue working because they can't afford to live on their pensions, according to that study, and another 7 percent want to work, but can't find jobs.

A system that fails half of the population, says economist Dean Baker, codirector of the Washington-based Center for Economic and Policy Research, can't claim to have succeeded: "It hasn't provided security to people." Piñera (who by the way works for Cato institute) himself didn't respond to numerous requests to comment on the dismal statistics.

adogg's picture

Freedom Fails - I will address just one issue from your comments. You said...

"...forecasting that as many as half of all workers won't be able to save enough to receive the minimum pension when they retire—even after paying into their accounts for 30 years—and will therefore rely on government subsidies."

This assumes the new privatized Social Security program is designed to provide 100% of one's retirement funds. This may be the case for a portion of those receiving Social Security now in the U.S. but anyone probably 60 and under right now knows they shouldn't expect Social Security to be their only source for retirement funds. I feel that is the mindset for a good portion of our older population but it is clearly irresponsible from here on out.

I'm not sure why you are so against the privatization. Maybe it's because you are progressive, or don't like any ideas that lead to less government intrusion in one's life and provides more freedom. The Chilean system worked...we should be looking into how to make it work here. The transition period would be the toughest part. It would take some time and require several unique financial mechanisms to implement...but is the current system worth defending? I don't think so. Just like Own said...starting now will cost is less than starting later. It's not like our government cares one bit about spending more than it receives in revenue.

Tom Owen

I don't know the writer of "Freedom Fails", but I would ask him (or her) to prove his contentions with facts or at least the source of the facts. His screed reads like a lot of opinion, without support. Identifying himself and giving us some background will give us some understanding of whether he is to be believed.
Thank you, Tom Owen