Building an Economy that Works for Everyone

Social Security Privatization in Chile: A Case for Caution

Proponents of Social Security privatization often trumpet the Chilean “success story.” Right wing economists (and the finance industry-funded think tanks that sponsor them) spin fabulous yarns about the way the free market transformed Chile’s pension system. In doing so, however, they leave out crucial parts of the plot. Privatization advocates paper over very serious problems with Chile’s social security program.

While the full impact of privatization cannot be known until the system completely matures, a number of troubling issues have already arisen. For example:

  • Transition costs have negatively impacted public spending.
  • Pension fund management fees are exorbitant.
  • Non-participation threatens the overall viability of the system.
  • Individual accounts replace less of low-income workers and women’s wages.
  • Private accounts leave workers susceptible to market downturns.

Given the distinct social, political, and economic differences between Chile and the U.S., the relevance of Chile’s privatization experience to U.S. policy-makers is debatable. While this concern is legitimate, we would be remiss if we failed to take note of the results of Chile’s 19-year social experiment.

A Need for Reform

By all accounts, Chile’s public pension program was foundering in the 1970s. The system was extremely complex, consisting of over 100 different retirement regimes. Contribution rates, retirement ages, and benefits all varied by type of occupation. Inevitably, perhaps, this excessive complexity resulted in substantial administrative inefficiency.

The retirement program’s funding situation was similarly dire. The system was not generating adequate revenue to pay retirees despite payroll taxes as high as 25 percent. Even with government general fund subsidies equivalent to 4 percent of Chile’s GDP, a substantial majority of retirees were receiving benefits at a level below the official minimum pension. Manual workers, for example, were supposed to receive benefits that would replace 70 percent of their wages, but by the 1970s the rate was closer to 20 percent.

The program’s numerous problems were exacerbated by widespread tax evasion. The pension system lost a significant amount of revenue to unscrupulous employers who skirted contribution requirements and to workers who joined the burgeoning underground economy. The fact that the Chilean government lacked the resources or the political will to adequately police the system no doubt contributed to the situation.

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