Southern Exposure: What Chileans can Tell us about Social Security

In 2005, Americans are going to be hearing a lot about Social Security reform. President George W. Bush has put the issue at the top of his agenda, and the debate is already dominating congressional hearings and Op-Ed pages alike.

Allowing workers to divert their Social Security earnings to private accounts is part of Bush’s larger plan to create what he calls "an ownership society," where public social programs including income insurance, healthcare, and pensions are transformed to individual, market-based ones.

Democrats disagree with this philosophy; they believe in maintaining a communal retirement system - a common contract and insurance policy among Americans that requires all to contribute as they work and allows all to benefit.

As the discussion gathers momentum, analysts are looking to other countries that have experimented with private retirement programs, primarily Chile’s private pension plan.

Chile was the first of many nations to privatize its retirement system, so their almost-25-year-old experiment provides perspective on the Bush plan. And Bush has even cited the Chilean program as a model for his own, calling it "a good example."

Looking towards Chile

Like the American Social Security system, Chileans used to have a public pension program that obliged workers to contribute and allowed retirees to draw benefits. But in 1981, then-dictator General Augusto Pinochet created a system of private funds called Administradores de Fondos de Pensiones, or AFPs, which are similar to 401(k) plans. By switching to private plans, Pinochet hoped to reduce government spending and labor costs.

From that point of view, the program has been a failure, since pensions still eat up more than a quarter of Chile’s national budget. But those who applaud the Chilean system, including President Bush, point to the amount that AFPs earn in interest each year -- the annual return rate -- which, on average, is a relatively high 10 percent.

Some economists say that AFPs stimulated Chile’s economy by encouraging job growth and foreign investment and by reducing deficit spending by the government. However, Chile’s economic growth in the early 1980s was not necessarily due to privatization.

People in favor of Bush’s Social Security reforms remark on these achievements, especially the high return rates. But those who question privatization talk about the amount of money that Chilean retirees are actually getting each month; they are collecting considerably smaller benefits than retirees who are still collecting from the public plan.

Why the meager benefits if there’s a high return rate?

The apparent contradiction of a high return rate that produces meager benefits can be explained with two words: high fees.

The Chilean AFPs have fees that total up to as much as 30 percent of the original contribution. These charges more than outweigh the high return rate, so many Chilean retirees are getting much less than they bargained for.

These fees include brokers’ commissions and sales costs, including charges that go to ad campaigns. (These campaigns are successful by the way, over 25% of enrollees switch AFPs each year because of the free toaster or higher return rate.)

The Bush administration has suggested that it would limit such fees for the American version. But as investment firms swell with Social Security contributions, they may become more politically influential, meaning that limiting their business practices may be hard to do.

Because of the high fees and small benefits from AFPs, about 90 percent of Chilean retirees in the private system would rather go back to the public one, according to a Chilean government official speaking anonymously with the New York Times.

Retirees unhappy with AFPs have even formed a group, called the Association of People with Pension Damage, which has over 150,000 members.

But Chile and the U.S. are not the same

Although the Chilean program is a warning to some and an encouragement to others, the Chilean labor system is drastically different from the American one.

Only half of Chilean workers are in the system since self-employed workers and independent contractors are not required to contribute to a pension account. This is quite a contrast to the American arrangement, where all documented workers contribute to Social Security.

Further, the Chilean system was created during a military dictatorship, so the people had no say in how it was designed; but Americans can tell their representatives what they like and don’t like about the Bush plan, or if they want it at all. In addition, the Chilean system is no longer voluntary, whereas American workers would be able to choose whether or not to participate in President Bush’s plan.

Nevertheless, the Chilean model may give us some insight into whether or not Bush’s plan will work - and of course, that evaluation greatly depends upon what you think a successful Social Security program means. Does it mean greater benefits for retirees? Does it mean economic stimulation? What are your criteria for a strong Social Security program?

To learn more about Bush’s plan, click here.

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Article Posted on: 2/8/2005