CHILE embraced neoliberalism more than almost any other nation, with its 1980 privatization of pensions a hallmark of its paradigm shift. The World Bank and International Monetary Fund were quick to laud General Augusto Pinochet’s government for the move, which more than two dozen nations copied, at least in part. Yet now the need for pension reform is one of the few issues on which Chile’s politicians and policymakers, whether right or left, agree. The system simply hasn’t delivered on its promises for retirees and taxpayers. And both as a symbol and a reality, this failure by a former economic star has fueled the widening rejection of neoliberalism and market-driven approaches in other policy areas.
Chile’s justification for eliminating public pay-as-you go programs (like Social Security in the US) and sending workers into a privately managed system of individual accounts was twofold: First, private funds would grow more and compound faster due to better management, meaning more money for retirement; second, the change would keep down public costs.
Four decades later, Chile’s system hasn’t worked as promised or expected. The creators anticipated that the average worker would save enough to earn 70% of their salary in retirement; the reality has been closer to one-third. They thought the new system would expand the number of workers with retirement funds; instead, nearly 40% of Chileans have nothing to fall back on. Rather than improve the lives of Chile’s elderly, most pensioners live on less than the minimum wage, with women hit harder than men.
The private system hasn’t let the government off the financial hook either. The transition period was always going to be expensive as the government footed the bill for those retiring on the public dime without receiving payroll taxes (as these contributions all headed to private accounts). But the government has also had to backstop far more of the new system’s retirees than expected. Officials thought less than 10% of wage earners would rely on public largesse for a minimum pension. Today, more than 40% need the government to step in.
The biggest beneficiary turned out to be Chile’s capital markets. Pension fund managers invested tens of billions of dollars accumulated in individual accounts into local equities and bonds, expanding and deepening these markets. This helped domestic and international investors, as well as large corporations. It did less, at least directly, for the savers.
Why did Chile’s experiment fail? The low private payouts to retirees reflect in part low contributions. Unlike in the US, Europe, and other places, employers were not compelled to contribute. That was left to employees. At 10% of their salaries, the inflows often aren’t enough to retire on, even after compounding for years. Small sums in means small sums out.
Add to this the years many workers don’t contribute at all. With one in four jobs in Chile off the books, many workers will, at some or many points in their economically active lives, not contribute. The self-employed also could choose whether to join, and many didn’t. Sporadic contributions lowered retirement nest eggs too.
And particularly in the program’s early years, excessive fees cut the initial pot that could grow over workers’ lives. Chile’s pension funds charge on flows not assets. Many funds were initially taking 25 or even 30 pesos of every 100 off the top (rather than say one peso a year for 25-30 years). Commissions have fallen significantly since then. Still, many charge 10% or more of the initial payroll deposits as their fee. In contrast, the administrative fees for US Social Security are less than 2% (in part because there are no marketing costs). With fewer pesos invested and compounding over time, the non-wealthy have found it hard to accumulate enough for a decent pension, even with good returns.
Which gets to the biggest drawback of private accounts for social security: They don’t, and indeed can’t, pool risk across the population. Social insurance originated with European labor unions and mutual aid societies in the 19th century, with workers and participants contributing to support their own retirees. While the pooled funds benefited the poorest or unluckiest among them the most, the better off voluntarily paid in more than they got back for the peace of mind that, if their fortunes were to deteriorate, they too would rely on these excess contributions of the more well-to-do among the group. Public social security systems do this on a national scale, pooling risk across workers of all industries and redistributing the funds among all those that have retired (and met minimum requirements).
Private accounts, in contrast, only distribute risk over the lifetime of a particular individual. You save in your working years to fund your work-free ones. High income earners contribute more and get more, while minimum wage earners are often unable to save enough to avoid penury.
In the end, privately managed systems can’t help those who need more support in their final years. Pooling risk across the entire working population is more important in more unequal economies and societies, as income disparities are bigger and more consequential.
Previous governments in Chile have tried to fix these problems. In 2008 Michelle Bachelet’s government created public pensions for those whose savings didn’t amount to enough for a minimum pension, as well as those outside of the private system, expanding to nearly six in 10 wage earners. In 2021, President Sebastian Pinera, whose brother was one of the private system’s designers, expanded the public component even more to cover the bottom 80% of retirees.
Chile’s new president and congress look to go further. President Gabriel Boric will put forward a bill in August to raise the minimum pension from just under $200 to match Chile’s minimum wage of roughly $300 a month and make it available to all retirees. He would all but end the current private system by making a public pay-as-you-go system the main pillar of social security. Private accounts would be relegated to a more 401K-style option for voluntary retirement contributions.
But reforming the pension system is harder and more expensive today as Chileans are already quite old: There are just four workers for every retiree. This ratio looks to worsen in the years to come, surpassing that of the US by 2050. Boric wants employers to contribute too, increasing the amount of money set aside to fund retirement. He also is proposing specific non-payroll taxes to underwrite pensions and other social policies, including new mining royalties and a potential wealth tax.
Pensions were never a good fit for strictly private management, as basic building blocks of the welfare state are definitive public goods. Yet the failure of the system has reverberated beyond the retirees trying to make ends meet. Pensions became a leading cause for the millions of Chileans who took to the streets in protest in 2019, spurring the formation of a Constituent Assembly to write a new Constitution that will be voted on in September.
The best path for pensions would be a reform that ensures adequate retirements for more Chileans. This requires a more robust public system with dedicated funding to sustain it. If legislators can make this happen, they can reduce the financial hardship too many of Chile’s elderly now face. And, to the benefit of democracy in both Chile and its neighbors, they could also thereby restore at least some of the political legitimacy that the old system helped to put in doubt.
BLOOMBERG OPINION
