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Privatise Social Security (The Chilean Model)

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October 25, 2011 – Comments (1)

The following is from a 2000 Economic Opportunity Institute report. http://www.eoionline.org/retirement_security/reports/SSPrivatizationChileCaseCaution-Sep00.pdf 

The United States and Chile are very different in many ways. Politically, the U.S. has a strong,

functioning democracy that has been in place for over 200 years. Chile, on the other hand, only

emerged from military rule 10 years ago. Chile’s economy, likewise, is much less developed than that

of the U.S. The U.S. has a per capita GDP nearly 3 times that of Chile ($31,500 vs. $12,500 in

1998).[20]

More importantly, America’s Social Security system is in a very different position than was Chile’s in

1981. Chile’s social security administration was highly inefficient. The U.S. system, in contrast, is run

extremely proficiently. All administrative duties are performed at a cost of 0.9 percent of net

contributions, or less than a penny per dollar contributed.[21] Moreover, Chile’s public program was

having serious funding problems. Even with substantial general fund injections and payroll tax rates

more than double those in the U.S., the system was not able to pay promised benefits. In the U.S.,

even according to the pessimistic projections of the U.S. Social Security Trustees, the system will be

completely self-sufficient and fully funded until 2037.[22] If economic growth in the U.S. continues at

the same average rate it has been for the past 50 years, then our system will be fully funded

indefinitely. With some minor changes to the program (i.e. lifting the cap on taxable wages), Social

Security in the U.S. would be fully funded past 2075, even under the pessimistic growth scenario of the

Social Security Trustees. Despite these differences, however, there are a number of lessons that we

can take away from Chile’s experience with privatization.

First, transition to a privatized system would be extremely expensive. In order to pay for the transition

to a fully privatized system, Chile had to drastically cut public spending, raise taxes, lower benefits,

sell government assets, and issue bonds. In the U.S., researchers estimate that even a plan to

privatize 2% of the 12.4% Social Security payroll tax would cost $74 billion per year, or 4% of the

annual federal budget.[23] This is a substantial loss of funding and would necessitate substantial

general fund transfers, spending cuts, tax increases, benefit reductions, or some combination of these

options.

(In advance of the next concern, I would like to remind readers of this video from Bloomberg TV, which basically explains how hidden fees are taking half the gains in your 401k. http://www.youtube.com/watch?v=08UPQ3JaRek )

Second, exorbitant management fees in Chile wipe out a significant portion of workers’ returns.

Experience with individual accounts in Britain suggests that administrative fees in the U.S. would

average 2.5 percent of assets per year. Over an average career and retirement, fees charged at this

level would reduce the total value of a worker’s account by 25 percent. Add in alteration costs

(incurred when a worker switches pension providers or temporarily stops making contributions) and

annuitization expenses and approximately 43 percent of the average worker’s account will be spent on

fees before the first retirement check is cut. [24]

Third, privatized pension accounts put Chilean women and low-income retirees at risk. The U.S.

Social Security system has a progressive benefit structure that replaces a larger proportion of

low-earners’ wages. Moreover, the system provides a guaranteed, inflation-adjusted benefit for life.

Economic Opportunity Institute http://www.eoionline.org/SocialSecurity/SS-SocialInsecurityChile.htm

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These features help low-income workers generally, but particularly help women (who tend to live

longer than men). Under a privatized system, these beneficial features would be lost.

Lastly, private accounts leave workers at the mercy of the market. In Chile, a market downturn in

1998 drained many retirement accounts leaving officials in the awkward position of urging workers to

defer retirement indefinitely. Privatization advocates in the U.S. note that the 70-year average real

rate of return on the stock market has been 7 percent. While this is true, it ignores the fact that the

stock market is very volatile. According to John Mueller, former economic counsel to the U.S. House

of Representatives’ Republican Caucus, the 20-year average real return on the stock market fell to

zero three times since 1900—from 1901 to 1921, from 1928 to 1948, and from 1962 to 1982.[25]

Factor in administrative costs and actual returns dipped significantly below zero during these periods.

Under these circumstances, workers would have been hard-pressed to save for a decent retirement

1 Comments – Post Your Own

#1) On October 25, 2011 at 7:20 PM, devoish (98.58) wrote:

http://caps.fool.com/Blogs/the-chilean-model/654119 

I would also like to remind folks that in 2008, Chilean citizens bailed out the privatised pension system and raised taxes to fund a public benefit for their poorest friends and neighbors. In the meantime they paid financial wizards half their gains to manage their funds - just like our 401ks - and then paid again to get their money out. As the Republicans hope to solve SSI without making the choice of actually funding it by lifting the cap, I will look to see the problems of the Chilean experience adressed by more than empty promises. Which I do not expect they will be able to do.

Problem one, If todays workers are paying for todays retirees, how will SSI's current retiree benefits be paid? Higher taxes, hope for growth, cuts in services to the poorest, cuts to teachers, tax on those who haven't paid high enough wages for the poorest to not need SSI?

Problem two, How will fees be made legible and clear to enrollees? Will Elizabeth Warren write the rules? Require that privatised plans only charge interest? Only a percentage of deposits, or gains? Or a fixed amount of fees declared on the first page? If you think an investment manager will not game the system, watch the 401k video.

Problem three. How big a Government will there be to prevent individuals and employers from cheating by not declaring income. This is a problem we are already not solving.

Problem four. What will we do when our personalisation fails our people as Chiles has failed theirs, as pre-SSI America failed its workers?

Best wishes,

Steven

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