U.S. Monitoring Chilean Pension Model To Learn More About Private System by Michael Coleman Chile has been getting a lot of attention from Americans latelyónot for its beautiful beaches, fabulous shopping or fascinating culture, but for something decidedly less sexy: its pension system. With President George W. Bush making Social Security privatization a cornerstone of his second-term agenda, U.S. pension expertsóand even some rank-and-file U.S. workersóare looking to learn more about Chileís 25-year-old experiment with private retirement accounts. Launched in 1981 under former Chilean dictator Gen. Augusto Pinochet, Chileís pension system has won both praise and scorn from outside observers and the Chilean workers who are forced to buy into it. The Chilean retirement modelóthe longest-running government-mandated private pension experiment in the worldóis the creation of U.S.-trained conservative economists who established an alternative to the old state-run retirement system in Chile, which was broken and bankrupt. The private system requires workers who entered the workforce since 1981 to contribute 10 percent of their wages to an investment that is managed by one of five mutual f und companies. The workers own their investment entirely and can carry their individually tailored plan with them from job to job. Neither the government nor employers contribute to the fund. The funds have produced slightly better than 10 percent returns, adjusted for inflation, since the planís inception. But many who have bought into the system complain that fees are too high and can eat up as much as a third of their original investment, and that participation rates are nowhere near levels promised by the government more than two decades ago. Guillermo LarraÌn, superintendent of the Chilean pension system, traveled to Washington last month to visit colleagues at the Chilean Embassy near Dupont Circle and to discuss his countryís retirement model with the cityís policymakers, academics and economists. Less than a week after the presidentís State of the Union address, LarraÌn, an amiable 40-year-old who sports stylish business suits and funky reading glasses, agreed to sit down with The Washington Diplomat to discuss some of the pros and cons of the Chilean system. LarraÌn was quick to point out that he does not understand President Bushís proposal well enough to critique it. In addition, the Chilean private accounts do not solve the problems of a pay-as-you-go system, which remain the principal means of government retirement support in the United States and Europe. But he said his first impression is that Americans would fare better in some ways and worse in others than Chileans have under their private system. ìYou will not have many of the problems we have faced, but you will also not enjoy some of the good things we have enjoyed.î Generally, Bush wants to restructure the U.S. retirement system to allow workers under the age of 55 to divert a portion of their Social Security payroll taxes into individual investment accounts in exchange for lower guaranteed future benefits. Under the presidentís proposal, workers could divert about two-thirds of their retirement taxes into private accounts such as mutual funds. The donation could be as much as 4 percentage points of the 6.2 percent that is withheld from their paychecks, as well as all of the 6.2 percent donated by employers. LarraÌn said a majority of Chileís workers are supportive of their private system, although he conceded that others believe it is too expensive or oppose it because it was created under the dictatorship of the highly controversial Pinochet regime. ìFor most of the workers, I would say the system works fine,î LarraÌn said. ìWho are those workers? Workers with formal employment and stable jobs.î LarraÌn said Americaís participation rates in the new system would likely be much better than those in Chile. Currently, as many as 25 percent of Chileans are part of the informal workforce, meaning they hop from job to job, are self-employed, or make so little that they choose not to make voluntary contributions into Chileís system. The rate of Americans working in the so-called informal economy is only about 7.5 percent, LarraÌn noted. ìYour labor market works better than ours,î he said. ìYou will have better conditions for people to save.î However, he added that the United States would not experience the dramatic strengthening of the economic sector that Chile did. ìOur reform made a big push in the development of the financial sector and that development created growth,î LarraÌn explained. ìWe created employment, wages and taxesÖ. Your financial sector is already developed, so you will not see that positive impact that we saw.î He conceded that the Chilean government made a mistake in overselling the benefits of switching from a state-run system to private retirement accounts 25 years ago. The more people invest in the funds, the stronger they become and the better the returns. But promises of participation rates reaching 80 or 90 percent have been proven to be bogus. Actually, only about half of the countryís workforceó7 million of 15 millionóparticipates in the program. As the first generation of workers retires under the new system, even many middle-class workers are finding that their benefits are far less than what they would have received under the old system. According to an article in the New York Times, ìFor those remaining in the governmentís original pay-as-you-go system, the maximum retirement benefit is now about $1,250 a month. The National Center for Alternative Development Studies, a research institute here, calculates that to get that same amount from a private pension fund, workers would have to contribute more than $250,000 over their careers, a target that has been reached by fewer than 500 of the private systemís 7 million past and present contributors.î ìMany people thought pension reform could save you from cancer,î LarraÌn said. He advises U.S. leaders to be careful not to promise workers too much in a move toward privatization because even in a well-designed system, other factors such as unemployment and market downturns can depress returns. ìThis is an important reform, but it has limits,î LarraÌn said. ìThe functioning of the system depends a lot on what happens in other markets where you donít have any control.î LarraÌn said he and others in the Chilean government have devised ìan original proposalî for getting the countryís pension fundsí fees under control to improve returns and minimize complaints from workers. He declined to explain it, saying it is ìquite technical,î but he said the new plan should increase the political popularity of privatization even though fund managers are not thrilled about the proposed change. ìThey are resisting because itís nice to earn money more than what you should, so there we have a point of conflict,î LarraÌn said. ìBut I think they realize that overall, for the social justification of the system, itís good to improve competition and diminish barriers to entry.î He also said the country must look at ways to improve participation rates. ìWe donít have any specific proposals for that yet,î he said, noting that the country is in the midst of a presidential campaign. ìNormally there would be more proposals.î The election, a contest between a Christian Democrat and a Socialist former defense ministeróboth of whom are womenówill take place in December of this year. LarraÌn repeatedly declined to assess or critique Presidentís Bush skeleton plan for partially privatizing Social Security, but he stressed that although he favors the private model, it alone cannot guarantee financial security for all Chileans. LarraÌn said the ideal retirement system relies on three pillars: a pay-as-you-go bare minimum pension cushion funded with help from the government, a capitalization system in which workers choose to invest a portion of their wages in the market, and individual savings. ìYou cannot think that only one of those pillars is the solution,î he said. ìThe solution lies in the linkage between the three of them. I advocate for the total package.î Michael Coleman is a contributing writer for The Washington Diplomat.