Mon. Nov 28th, 2022

Populist politicians are destroying Chile’s revolutionary pension system. In 1981 Chile became the first country to privatize social security, ending the pay-as-you-go system that had been in place since 1924 and had collapsed. Now Chile’s left wants to resurrect it.

The state-run pension system was plagued by corruption and rent-seeking since its earliest days. Among the 11,395 laws passed by the Chilean Congress between 1926 and 1963, 10,532 granted pension privileges to special-interest groups, many of them politically connected. In 1968, Chilean President

Eduardo Frei,

a center-left Christian Democrat, described the cronyism that plagued social security as an “absurd monstrosity” that the government couldn’t afford.

Pension privatization reversed this perverse dynamic. Instead of taxing active workers to pay pensioners through the bureaucracy, the new system, created by former Labor Minister

José Piñera,

established that 10% of the employee’s salary is transferred automatically to an account under his name at one of the Administradoras de Fondos de Pensiones, or AFP. These private pension funds compete to attract workers and invest their pensions for a fee.

This has restored the link between contributions and pension benefits by making workers responsible for saving the funds that will support them once they retire. This novel system also limited corruption and rent-seeking, and Chilean taxpayers are no longer on the hook for pension deficits, which in 1981 represented 3% of gross domestic product.

In Chile, the ratio between active workers paying into the pension system and retired workers receiving benefits had declined from more than 10 to 1 in 1924 to about 2 to 1 in the late 1970s, while the payroll tax increased from 5% to 51% in some cases. By subsequently relying on workers’ own savings to fund their pensions instead of taxing younger workers, privatization of social security ended dependency across generations.

The AFP system also brought inflation-adjusted pensions and paid benefits regardless of how many years workers contributed to their savings accounts. Under the old system, no pension was given to workers who failed to pay for at least 15 years into state coffers. Only workers in groups with special benefits could expect a different deal.

Average pensions are also 41% higher in the AFP system than in the old one, according to the Libertad y Desarrollo research center, even as workers contribute a smaller fraction of their salaries. Between 1981 and 2019, the savings accumulated in workers’ accounts at the AFP reached $218 billion, or around three-quarters of GDP. About 70% of these funds weren’t contributions made by workers but profits generated for them by AFP investments. This accumulation of capital contributed an extra 0.5% of GDP a year to economic growth between 1981 and 2001.

Pension payouts, however, are typically low. The average pension is less than the minimum wage. Populist politicians blame the AFP, but it isn’t uncommon for workers to drop out of the workforce for long periods, and government statistics show that 10 years of gaps in savings can cause a 50% decline in pensions. Official data also shows that in 2018 Chilean workers saved only 53.5% of their labor time, creating gigantic contribution gaps that translate to lower pensions. The main reason is that many workers do informal jobs that don’t pay contributions into the savings accounts.

Longer life expectancy is also a problem. When the AFP system was created, men retired at 65 with an average life expectancy around 67. Women retired at the age of 60 with a life expectancy around 74. Today, the retirement ages are unchanged but life expectancy has increased to 77 for men and 83 for women. This means more years of retirement have to be funded by the same years of saving.

These and other challenges could have been addressed by increasing the retirement age, introducing more flexibility to the labor market, raising the contribution rate from 10% to the Organization for Economic Cooperation and Development average of 20%, and creating incentives within the system for workers to increase savings. But the prevailing populist climate has made these reforms impossible. As a result, support for the AFP collapsed, leading to the passage of reckless legislation.

Between June 2020 and May 2021, around 10 million people in the AFP system have been allowed to withdraw their savings from AFP accounts. Official estimates indicate that around half of Chilean workers in the system will end up with no savings in their AFP retirement accounts while future pensions are expected to decrease by nearly 30% on average.

Last year a group of senators even introduced a bill to nationalize the pension funds, as Argentina did in 2008. An expropriation of workers’ savings looks increasingly likely, as the radical left dominates Chile’s recently elected constitutional convention. “The destruction of the AFP system is under way,” a far-left lawmaker recently said. She is right, but the excuse for the destruction is just that.

The attack on the AFP system is all about ideology and power. The privatization of social security was the reform most emblematic of the so-called Chicago Boys in the Pinochet regime. Its destruction has long been a goal of the radical left. With the AFP out of the picture, politicians will recover the power they once had over retirees.

Mr. Kaiser is a senior fellow at the Atlas Network Center for Latin America.

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