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Chile could hold lessons for U.S. Social Security debate

© St. Petersburg Times
published April 17, 2002

SANTIAGO, Chile -- Chileans are watching with interest as the U.S. Congress debates President Bush's proposal for a partial privatization of Social Security. Chile privatized its national pension system 21 years ago, and supporters say it offers a model for the United States.

"It would be a big advance for American workers," says Guillermo Arthur, president of the association of Chile's pension mutual funds.

But some trade unionists and pension experts say the Chilean system provides inadequate pensions and will eventually require big government subsidies. The main beneficiaries, says law professor and pension expert Juan Gumucio, are the mutual fund managers.

"They make more money than drug traffickers selling white powder," he says.

The debate about social security in Chile bears a strong resemblance to discussions in the United States.

In 1981, midway through the dictatorship of Gen. Augusto Pinochet, Chile's social security system faced bankruptcy if the government didn't provide more subsidies. A group of U.S.-trained economists recommended privatizing the system, creating something like a mandatory national 401(k) plan.

Ten percent of a worker's wage is automatically deducted and sent to one of several independently managed mutual fund companies selected by the worker. Workers can choose to have a greater amount deducted. The contributions are tax deferred and remain under the worker's control if he changes jobs. Neither employers nor the government contribute to the accounts.

The vast majority of working class and many middle class Chileans don't have private pensions or other sources of income after retirement. So their retirement income depends on how much they save in the mutual fund and on their investment choices.

Before 1981, Chilean employers paid about half of a worker's pension contribution. Eliminating such contributions doomed Chile's system from the start, argues Jorge Millan, pension specialist with Chile's main union federation, because workers can't save enough for a decent pension.

"The pension system was created during the time of the military dictatorship when there were no parties, no voting," he says. "The Chilean pension system won't succeed in any democratic country."

But supporters of the system say many retirees do quite well. The average monthly pension is $450, according to government statistics. And the mutual funds have grown an average of 10.7 percent over the past 21 years, even taking into account the economic downturn of 1995-98. The seven pension mutual funds have combined assets of nearly $40-billion.

The system has proved itself over time, according to Luis Larrain, a member of the board of directors of Habitat, Chile's second largest pension fund.

"There has not been a bankruptcy," he says. "Nobody has stolen the money from the workers. That was the typical argument against private administration."

He maintains that Chile's system is superior to U.S. 401(k) plans because employers cannot require employees to own company stock in their pension accounts, as occurred at Enron.

Yet critics say serious flaws have emerged in Chile's system. The Chilean government guarantees a minimum pension to anyone who has worked as a regular employee for at least 20 years. The government makes up the difference between the monthly income received from the mutual fund and the minimum pension, which is indexed for inflation.

Today the minimum pension is $110 per month compared to a minimum wage of $156 per month.

Law professor Gumucio maintains that by the year 2010 as many as 60 percent of retirees will qualify for no more than the minimum pension. A government pension consultant estimates the figure at 30 percent. Larrain cites lower figures, saying minimum pensions will account for 15-18 percent of the total.

The figures vary widely because of the difficulties of predicting the future health of the economy and how much retirees will have contributed to their accounts. Depending on whose estimates prove correct, however, the government could potentially spend billions subsidizing those minimum pensions.

The Chilean system faces another financial time bomb. While the Pinochet dictatorship required ordinary workers to shift to the privatized system, the military and police stayed in a government-sponsored plan that pays much higher benefits. The government must continue to subsidize those pensions.

The total deficit in the system -- including payments for minimum pensions and military/police pensions -- averaged 5.7 percent of Chile's GDP from 1981-1998, the latest government figures available.

Forty-two percent of Chile's work force aren't covered by any pension system at all. They are mostly independent contractors and workers in the informal economy.

Mutual fund managers try to encourage voluntary participation from this sector but face an uphill battle. Street vendors and independent taxi drivers don't earn enough to put 10 percent of their wages into a mutual fund. Larrain says the government will have to legislate special tax incentives to encourage these workers' participation in the system.

Other Chileans have been victimized by fraud. Some small and medium size employers deduct the mandatory 10 percent from workers wages but fail to send the money to the mutual fund. These losses currently amount to $500-million and are not covered by either the government or the mutual funds.

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