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Briefing and Opinion
March 4, 2005

Chile: Greater Risks, Greater Rewards

Politicians who are pushing for the partial privatization of Social Security say the future lies to the South. Chile is one of a handful of countries that have privatized retirement. Rick Karr travels to Santiago to ask how the Chileans are faring under the system.

Fans of the privatized retirement system here in Chile say "Why not try it in the U.S.?" Why not replace Social Security, its bureaucracy, and its guaranteed payouts with something more like our own personal accounts -- where the money's invested in the stock market. In the long run, they say, we'd get better returns.

Pinochet Chile privatized its system 24 years ago, when the military dictatorship of Augusto Pinochet imposed the reform. Jose Pinera was the architect of the plan; for years, he's been singing its praises in Washington. Pinera says the old Chilean system was pay-as-you-go, like Social Security in the U.S. and it was broken.

"People didn't have ownership of their money," says Jose Pinera. "The benefits of retirement depended on politics -- on whether the budget was in surplus or deficit, whether there was a crisis. How can you have a system of Social Security when really you are not secure about whether your benefit will be there? Therefore we decided to give people ownership of their money."

The centerpiece of the Chilean plan is a group of six companies known as AFPs -- in English, administrators of pension funds. When young Chileans like environmental lawyer Cecilia Urbina enter the work force, they choose one of the firms to invest the 10 percent of their income that's withheld for their pensions. Cecila Urbina

By law, each of those companies offers five plans -- much like mutual funds -- which range from risky and potentially profitable to safe, but less sexy. Cecilia Urbina says it's a tough choice. "I think that all this information sounds too complicated for the average consumer," says Urbina. Once she makes a decision, Cecilia Urbina's pesos will join the billions in pension investment that have poured into Chile's stock and bond markets.

All of that investment capital has funded new toll roads that operate at a profit and thousands of mortgages. Pinera says privatizing Social Security has helped Chile's economy become the fastest-moving in South America. "This has increased the capital market," says Piñera. "This has helped Chile to double its rate of growth."

Looking at Chile's privatized pension system from the height of a few thousand feet, it's clear that it's been good for Chile's economy as a whole. What's less clear is whether it's been good for individual Chileans.

carrot salesman Return on investment has been good -- an average of more than 10 percent a year. But it's been inconsistent: some years, the plans lose money. and critics say Chileans pay too much in overhead -- fees, marketing costs and profits. But supporters say the AFPs have lower overheads than most mutual funds.

At Santiago's central produce market, Chile's system generates a lot of skepticism, says one man selling onions, "They've done nothing. All this government does is build roads but you can't eat roads." Says another man selling carrots, "If you aren't educated about it you're basically relying on luck."

Many Chileans say the private pensions do not pay as well as the old ones. seventy-two-year-old gardener Aniseto Medina agrees. He still works because when he started drawing on his pension a few years ago, it paid only about a quarter of his old salary.

Aniseto Medina "Clearly I consider the 70,000 pesos I receive to be a paltry sum," says Medina. "You can't do anything with 70,000."

Lawyer Cecilia Urbina, who's just joining the system, says that unlike her parents and grandparents who had the option of sticking with the old system or joining an AFP, her generation has to buy into the private system. All she can do, she says, is hope for the best. "I have no idea how the new system will work with the new generation," says Urbina.

Just how relevant is the Chilean system to the U.S.? Critics say its most important lesson is that it's expensive: Chile continues to pay pensions from its old system at the same time that it's building up the new one. That transition has cost between two and five percent of gross domestic product every year for 24 years. Fabio Bertranou of the U.N.'s International Labor Organization says the transition won't be paid off for another 20 years.

"If you don't have the instruments to finance the transition costs, I wouldn't recommend to go to this type of reform," says Fabio Bertranou. In other words, if you're running a budget deficit, don't even think about instituting a system like this.

Bertranou Bertranou says Argentina looked at Chile, liked what it saw, privatized social security -- but failed to account for the costs and that helped lead to an economic meltdown. But the architect of the Chilean plan -- Jose Pinera -- says the transition costs just do not matter.

"I believe passionately -- because I have seen it working -- that a system of personal retirement accounts is morally, economically, financially and politically superior to a system of entitlement where you depend of governments, where there is no funding, where it's very easy to go bankrupt because of demography, because of political manipulation," says Pinera.

Ultimately, politicians on Capitol Hill will have to weigh the benefits of the Chilean system against its shortcomings as they decide whether it fits the United States at all.

Q&A: Lessons from Chile >