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Chilean Social Security Reform

Council On Hemispheric Affairs - http://www.coha.org/
Monitoring Political, Economic and Diplomatic Issues Affecting the Western Hemisphere
Memorandum to the Press 05.68
Word Count: 1750
Tuesday, July 5 2005

Chilean Social Security Reform; Risking American Workers Pensions on the Dubious Success Pinochet's Economic Strategy

• President Bush is touring the nation this summer in an effort to gain support for his social security reform plan, which was in part bequeathed to him by the Chilean dictator and quite properly faces widespread public and congressional opposition in the U.S.

• Bush points to Chile’s pension system as a model for U.S. reform. However, the success of this plan for old-age assistance is questionable.

• The Chilean pension system compromises the safety of workers’ investments by risking steep market fluctuations in hopes of gambling on augmenting retirement funds.
Furthermore, high marketing costs and bamboozling salesmen can slash the real value of pension accounts.

• After having devoted much of his second term so far to promoting pension privatization, Bush has not yet been able to secure wide public support for his reform plan. Considering the thunderous public opposition to social security privatization, Republicans now fear a backlash from the proposed reform due to the upcoming 2006 mid-term elections.

Once again on the road early this month to attract popular support for his plan to privatize social security, President George W. Bush has proposed a model for pension reform based in part on the formula adopted in 1981 by the regime of Chilean military dictator General Augusto Pinochet. Both the circumstances under which the Chilean system was implemented in 1981, and its questionable success over the past quarter century, raise serious doubts as to its potential for successful application in the U.S.

The Chilean Pension System

Following the coup that overthrew democratically-elected President Salvador Allende in 1973, Pinochet instituted a broad network of neoliberal social and economic policies, the costs of which characteristically fell on the shoulders of the members of the lowest economic strata. One of these initiatives, pension privatization, was the creation of labor and social security secretary, José Piñera, a staunch free market proponent and a member of the hard-line privatization group, the “Chicago Boys,” who, in recent years, has been on the staff of the conservative libertarian CATO Institute in Washington. Much of Piñera’s enthusiasm for an open market policy driven by the private sector came as a result of his education during the 1960s at Catholic University of Chile under the direction of the University of Chicago’s Economics Department. Inspired by such neoliberal professorial luminaries as Milton Friedman and George Schultz, Piñera developed a market driven philosophy of Chilean pension reform.

Established under Decree Law 3,600 in November 1980 and instituted on May 1, 1981, Piñera’s pension plan called for the mandatory privatization of workers’ retirement accounts under the control of Administradoras de Fondos de Pensiones, or Pension Fund Administrators (AFPS) which manage the investments. Presently, after contributing a minimum of ten percent of pre-tax wages into their accounts, workers have the ability to decide which of the AFPS they want to manage their investments and the type of investments they want to make, including the desired level of risk. Upon having made twenty years of contributions and reaching the minimum retirement age, workers may receive account payouts, purchase an annuity or a combination of both. Unlike the traditional social security model, in which present workers’ contributions fund current retirees’ benefits, workers’ pensions are based on their personal account contributions.

Compromising the Stability of Retirement

On a basic theoretical level, Chile’s privatized pension system is antithetical to the concept of a social protection program. Piñera maintains that the superiority of the privatized system is derived from its foundational difference from the former Chilean and current U.S. “pay-as-you-go” template of social security. According to Piñera, the traditional pension model is inherently flawed because it destroys the connection between personal effort and reward. However, this argument may ignore the basic rationale behind publicly-supported programs, particularly social security, which was designed to provide for the elderly, disabled and dependent in the case of unexpected disasters including financial loss and unanticipated early death. By removing society’s support and by placing the full responsibility for dealing with these crises on workers’ personal contributions, pension privatization, so says its advocates, removes the safety net fundamental to any bona fide plan for social security.

Piñera also justifies the superiority of his pension plan to the current U.S. program by asserting that the Chilean system catalyzes worker interest in market activity. According to privatization proponents, the inability of workers to engage with their financial contributions in a government-funded pension system helps create an atmosphere of disinterest in the values and activities of the private sector. In fact, rather than placing financial control in the hands of workers, Piñera’s system is willing to make workers’ accounts vulnerable to market fluctuations by placing the success of their investments and the stability of their retirement prospects under the control of unpredictable external market activity. Though workers may be aware of their account’s fluctuations, it is more likely that it will be out of the shock of monetary loss or the fear of investment depletion than through mature financial comprehension. Making workers aware of their economic fate is hardly worth the corresponding risk to their future social security.

Transition Costs: Evidence of Domestic Failure

During the transition to privatization in Chile, workers already collecting pensions from the government were given the choice to remain in the existing system or set up a private account under the reformed plan. Meanwhile, workers just entering the workforce were required to comply with the provisions of the private account reform. As a result, the government had to continue paying workers who remained in the current system until all survivors would be incorporated into the private account plan. Today, since young workers no longer contribute to existing retirees’ pensions, the Chilean government must pay all the cost of the remaining pensions. According to an account in the Boston Globe in February 2005, Chile continues to pay 30 percent of its annual budget toward pensions, a “staggering amount.” Such an elevated government contribution necessitates a long-term spending commitment. In Chile, this commitment has tied the government’s hands encouraging it to realize its desire to retrench on government spending by privatizing other sectors, such as health care, reducing funding for remaining social programs, weakening the state’s ability to provide protection and to extend services for its most vulnerable citizens.

Privatization’s Real Beneficiaries

Implemented during the period of Pinochet’s military rule, Piñera’s plan for reform was instituted in a decidedly nondemocratic manner. At the time, Chile was characterized by a political environment featuring a suspended constitution, a shuttered parliament and government censorship. Forcing a broad change in the design and workings of a fundamental social institution like a country’s pension system, under the conditions of a dictatorial military regime, can only undermine such a program’s core objectives. For example, military personnel, a powerful constituency in Chile, were exempt from the transition to private accounts and were allowed to remain in the government-funded program. With 17 members of Pinochet’s former military regime serving as trustees of AFPS, according to Indira A.R. Lakshmanan with the Boston Globe, the real beneficiaries of the plan remain suspect. Furthermore, the competition between multiple AFPS to establish large client bases creates high marketing and administrative costs that are negatively reflected in account balances, which contributes significantly at times to the decline in value of a worker’s retirement holdings.

A social system benefiting wealthy business interests at the expense of workers who are dependant on future pensions has to be a dubious precedent for U.S. social security reform. The subordination of democracy to the desires of Chile’s military and business elite betrays the true intention of an economic plan supposedly designed to benefit the Chilean population across all socio-economic strata. A similar fate is likely in store for pension reform in the U.S. under Bush’s privatization plan. While Washington’s application of the privatized system would lack the dictatorial foundation on which Chile’s program was based, it would undoubtedly owe much of its guardianship to powerful financial corporations and Wall Street.

A Conditional Success for Chile’s Pension Plan

In reality, the purported success of the “Chilean miracle” was actually, in large part, a result of re-regulation and de-privatization strategies underlying Pinochet’s economic reforms adopted after Chile’s debt crisis and recession in the early 1980s. In fact, the World Bank, a strong champion of neoliberal reforms, has since reeled in its unmitigated support for the nation’s privatization zest, noting in a December 2004 study that the reform has failed to incorporate a widespread portion of Chile’s pensioners, resulting in high levels of old age poverty. According to the Economist, the World Bank has also incorporated two additional pillars into its design for pension plans, one of which, -“the tax-financed safety net”- provides for the privatization processes’ reoccurring failure to benefit all social strata. The reforms instituted under Pinochet resulted in growth in Chile’s GDP only in the mid 1990s, after a return to a system of regulated banks and the protection provided by a considerable degree of democratic leadership once Chile reverted to civilian rule.

U.S. Application

With President Bush determinedly pushing his own Social Security privatization plan in a nation-wide effort to drum up support, and with the Republican leadership considering bringing the pension reform issue to Congress before its August adjournment, U.S. application of the Chilean system is likely to be the focus of a furious debate over social security reform. The likelihood of success for the U.S. program seems improbable considering the problems experienced by Chile. The voluntary privatization of social security in this country would be certain to face many of the same transition costs associated with those attendant to “personal accounts,” Bush-speak for privatization, which offers up a confusing choice for an administration originally derisive of what it sees as an excessive governmental role. Similarly, since the implementation of the privatization plan will be optional and gradual, the current and future benefits for workers in the existing social security plan will require continued government funding, a prospect at odds with the administration’s general lack of desire to save a fiscally ailing federal benefit program. The predictable large-scale funding necessary for the transition to a voluntary account system would create an uncomfortable fiscal responsibility for the federal government. Workers would also assuredly oppose the management fees charged by the private investment administrators, which would eat into investments and especially hurt low income workers. Chile’s plan is clearly not the “great example” described by President Bush, and although he has yet to provide a detailed description of his privatization proposal, its potential for success is hardly guaranteed, even in its formative stage.

This commentary was preapred by COHA Research Associate Kaitlyn Powles.

July 5, 2005

For More Information:

Lakshmanan, Indira A.R. “Poor Chileans labor past retirement.” Boston Globe. 28 February 2005.

“ Keeping the Promise of Old Age Income Security in Latin America.” World Bank. 13 December 2004.

“ Pinochet’s rule: Repression and economic success.” BBC News. 7 January 2001.

“ Second thoughts on the third age; Pension reform.” Economist. 19 February 2005.


The Council on Hemispheric Affairs, founded in 1975, is an independent, non-profit, non-partisan, tax-exempt research and information organization. It has been described on the Senate floor as being “one of the nation’s most respected bodies of scholars and policy makers.” For more information, please see our web page at www.coha.org; or contact our Washington offices by phone (202) 223-4975, fax (202) 223-4979, or email coha@coha.org.

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