Two experts offer perspective on the pros and cons of private retirement plans. José Piñera is the architect of the Chilean private system and founder and president of the International Center for Pension Reform. Fabio Bertroneau is a senior social security specialist with the Chilean International Labour Office.
Q: Why not give people entering the work force the choice between a pay-as-you-go system and a private system?
The pay-as-you-go system is going bankrupt all over the world due to demographic reasons, as we know. It would be completely irresponsible to keep the door open to a system where we'll not be able to pay the benefit in 40, 45 years. So the young person enters the system of private retirement account.
In Chile, we gave every single worker who was already in the social security system the option of staying in the government system, or opting out and putting all the FICA tax in a private retirement account. The incredibly good news is that 95 percent of Chilean workers decided freely to move to the new system. This was the silver bullet to explain the system to the people. Because if someone says, "Oh, I don't like the private retirement account because they are risky." Well don't take them.
Q: Has the private scheme been helpful for all Chileans?
I think there is an important heterogeneity in the labor market and not every worker has benefited from this system. The workers that benefit from these systems are those that usually have higher earnings and can take advantage of the system. Workers that do not meet these characteristics won't benefit from the system and they will rely on other Social Security programs in Chile that coexist with the AFB [firms that act as administrators of pension funds] system.
It's interesting to see that only about seven percent of the self-employed workers are participating in the system. This shows that one of the keys for the success of the system is that you have to make it mandatory system and you cannot allow workers to opt out because they may prefer to use other vehicles, other means to invest their savings.
Q: How did Chile pay for the transition?
A: First of all we reduced government spending. We issued some debt, but it's not new debt to the country because it's just a way of recognizing the liability that the pay-as-you-go system had anyway. That debt will be paid when the old pensioners begin to pass away. We increased economic growth, and therefore tax revenues, not by increasing the tax rate but basically by economic growth.
There are many ways to finance the transition plan because there is no economic cost in doing this reform. The GNP doesn't go down. There is a confusion in America about the cash flow problem -- that you have to come up with the money now, in order to reduce future debt. But it's not an increase in the total amount of debt. On the contrary, moving to personal retirement accounts decreases the total.
Q: On average, how long will the transition period last?
The transition costs are very high when you move to private accounts because you start allowing current contributors to put their money aside. You lose one of the main sources of financing of social security. In Chile, we will continue paying the transition costs for another 20 or 30 years. The entire transition period can take 20, 30, 40, 50 years. It depends on the maturity of the old system, how many people you have to retire with the old system.
Q: Would you change anything about Chile's private pension system?
I would put the supervisory authority outside the realm of politics. Now, regrettably, when we did the reform in Chile in 1981, we had never had a tradition of a government agency independent of political power. Why is this independence necessary with the pension system? Because the supervisory administration -- which has been up to now very serious and very technical -- is beginning to show signs of political intervention.
The politicians are calling the superintendent and saying, "Why don't you criticize the system a little? We are socialists. You should not be praising a capitalist system." The superintendent is now torn between his duty to supervise the system (his real duty) and surviving because he can be fired tomorrow by the president. So, I would make that an independent body maybe approved with senate approval.
Q: Who should decide how the private retirement plan functions?
In Chile, this system was implemented during a dictatorship and there was military regime that implemented the reform. There is a question about whether there was enough participation and enough discussion between the different actors, particularly workers. The question for the U.S. is, "What is the role, not only of Congress, but other social actors?" I think that the most important actors are the government and Congress, but also workers and employers in large and small firms.
Q: What about the risk that someone nearing retirement could be forced to keep working due to a downturn of the stock market?
Common sense! Who will be in the market at 64 years and 11 months? Aren't you a responsible person that at 55 will move to a bond portfolio? To a fixed income portfolio? In Chile, people begin at 55, 56, 57. They begin to move toward bond portfolios, or fixed income portfolios. Then instead of getting seven percent, or eight, in a stock they get five or four. But they sleep very well the last ten years of their working lives.
Thomas Jefferson talked about the freedom of people to vote, because they have common sense. In the U.S. you choose sheriffs, judges, senators, the president. Ah, but people will not think that they should not be in the stock market -- the day before they retire?
Q: Have Chileans been savvy enough about the private plan to be able to invest their retirement funds wisely?
Certainly there is the possibility of confusion. There was a survey that was done by the University of Chile a couple of years ago that showed that about 90 percent of contributors to the system don't have a clear idea of what the administrator is charging for their services.
Then there is also a lack of knowledge of how to invest or how to choose betwen these different funds that are offered by the AFPs. I would say that workers with high income can benefit because these are more educated workers. But this possibility of having multiple funds and having complex administrative and fee structures, is difficult to understand for an average worker. This is a major concern for the AFPs -- pension fund administrators -- they have tried to run educational programs.
Q: Who benefits most financially from the Chilean system: the people or the private fund adminstrators?
In a defined contribution system like personal retirement accounts, there are only two basic metrics, two ways for a person to evaluate success. Is your money safe? Nobody's stealing it, nobody's making funny games? Second, has it given me a good return? Now, what is a good return? Well, we may say that it is four, five, six percent. Well, in Chile, it has been 10 percent above inflation.
Now, you are saying to me, "Yes, but maybe someone else is making money." Well, that was Karl Marx's worry. If I go to Starbucks and the coffee is good and they charge me a good price, do I care whether the guy who founded Starbucks is making money? I know that in the free market scheme, if he's making too much money, there will be a Starlight that will charge me one cent less for my coffee. In the case of Chile's system, it is absolutely clear that the money is safe and you are getting 10 percent real return. All the rest is irrelevant.