Chile Con Economy?

In the early days of the U.S. debate about Social Security privatization, advocates would regularly trot out Latin America, Chile in particular, as the region that did it right, the model that the United States should learn from. Recently, though, this dog and pony have remained backstage, in spite of the Bush administration's current tour to promote private accounts.

Unfortunately for the privatizers, the World Bank, one of the primary drivers of pension reform in Latin America, has backed away from its earlier enthusiasm. In a remarkable, if carefully guarded, retreat, the bank published a report in late 2004 that owns up to deep problems in the reforms that it pushed for a decade earlier.

It is worth looking at these problems before we bring them on ourselves.

In the 1990s, the World Bank persuaded Chile, Peru, Colombia, Argentina, Mexico, and six other Latin American countries to reduce public pensions financed by current taxes in favor of mandatory private saving accounts. Privatization of pensions was supposed to help government finances, encourage development of domestic capital markets, and improve pension coverage.

These reforms were followed with great interest by advocates of Social Security privatization in this country. Advocates of privatization at The Heritage Foundation, the Cato Institute, FreedomWorks, and the Center for International Private Enterprise have assured us for years that “the global pensions revolution originat[ed] in Latin America. An experience born in Chile has become a model for the rest of the world.”

What exactly has the World Bank revised in its appraisal of Latin American pension reforms? And what can we learn from this entire evaluation process? We will answer these questions by noting some of the World Bank's central points in its own words:

  • The World Bank should change its focus from improving government finances to another goal: protecting old people from poverty. “Whereas a primary (though not exclusive) objective of prior [World Bank] efforts has been to improve the public pension system's fiscal health or help governments better administer and regulate the systems, the principal objective of this inquiry is to try to determine whether participants (not just the administrators or providers) in pension systems are better or worse off … .” [Emphasis in original]
  • Viewed in this light, the reforms are not complete. “[W]e look back and ask whether the decade or so of reform has been as success. The answer is that in many respects, it has. But if the new structures are viewed as a final design, the effort may well be assessed harshly. … The greatest dangers to all that the reforms have achieved lie … in countries where large mandated saving is viewed as a solution for the ages.” “[T]he poverty prevention pillar should get a lot more attention than it has in Latin America during the last decade.” [Emphasis in original]
  • After reforms, coverage has remained low, and workers are opting out of the system, leaving them impoverished in old age. “[C]overage ratios have stalled at levels of about half the labor force in those countries where workers' participation is highest. [M]any workers cease to contribute to the pension system after completing the minimum contribution requirement … revealing a preference for government schemes for pooling resources to insure against old age poverty.”
  • Moreover, the operating costs of private pension funds have been unacceptably high. “In Chile and a few other countries, commission rates are slowly coming down to reasonable levels (less than 20% of contributions or 1 percent of assets) … [but] the fee structure in Chile and elsewhere also results in inter-generation inequity as poorer workers end up paying a larger share of their contributions as commissions. … But most worrisome are findings that point to difficulties in regulating the firms that manage mandatory pension funds.”
  • Most damningly, the Wold Bank questions the whole rationale for replacing guaranteed pension benefits with mandatory private accounts. “If mandatory schemes are needed because of shortsighted workers, how can these same workers be counted on to make wise investment decisions?”
  • And if workers interests need to be carefully protected through regulation of investment funds, why not simply have government operate the funds? “If government regulates and guarantees the plans, won't it eventually end up controlling these funds? That is, does it really make a difference whether the funds are privately or publicly managed?”

    It is brave of World Bank officials to publish this volume, because it is clear to the careful reader that the authors no longer think mandatory private accounts replacing guaranteed minimum benefits are the basic shape that Social Security reform should take.

    Privatization has not simply been put in the back seat. It has been dropped entirely. Instead of “private versus public,” the authors suggest that we should be looking at other issues. What should the mix be between social insurance (pooling the risks of old-age poverty) and saving (each individual spreading his or her lifetime consumption over working and retirement years)? How much saving should be mandatory, and how much voluntary? These are the key issues.

    It seems the authors of the new World Bank study would have no problem leaving management of mandatory saving to the government sector. After all, if management costs at the federal employees Thrift Savings Plan are one-tenth of the “low cost” Chilean private accounts, shouldn't the lowest cost be prescribed for mandatory saving accounts?

    And if the “first pillar” of a pension system -- the guaranteed pension that protects the old from poverty -- is being run well (or contracted out), at minimal cost, by a public entity, why even consider replacing it with private accounts?

    The World Bank has quietly laid the groundwork for carefully downsizing the role of mandatory private accounts in its pension program for Latin America. Guaranteed pensions, not mandatory private accounts, deserve increased attention.

    In fact, roles have been reversed. Perhaps Chile should look to the model presented by the universal guarantees, efficiently provided, by the U.S. Social Security system as it moves ahead with further pension reforms.

    Bernard Wasow is an economist and a senior fellow at the Century Foundation.

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