Privatise Social Security (The Chilean Model)
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
5 of 7 1/9/2008 4:21 PM
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
RSS Headlines
Fool UK