Saving Social Security through Privatization

Article excerpt

House Republicans, GOP presidential contenders and others involved in the emerging debate on Social Security reform are examining a model from an unlikely source: Chile. Fifteen years ago, Labor and Welfare Minister Jose Pinera spearheaded an effort to privatize that country's failing program. Today, the Chilean system offers retirees returns of 10 percent on their pension investments. Argentina and Peru have initiated similar reforms, as have other countries around the world.

The United States soon may follow. The Cato Institute, an influential free-market think tank based in Washington, has enlisted Pinera to chair its Project on Social Security Privatization. In Congress, Rep. Jim Kolbe, Republican from Arizona and leader of a 40-member Social Security reform caucus, and Rep. Mark Sanford, Republican from South Carolina and sponsor of a privatization bill, both advocate Chilean-inspired ideas. And presidential hopefuls including Steve Forbes have spoken positively about the South American system.

"We've looked at several policy alternatives," Michael Tanner, director of Cato's health and welfare policy team, tells Insight. "Even the World Bank, which advises developing countries, warns against adopting the U.S. or Western European model of social security. It is just not sustainable. But Chile's is."

According to a recent Cato study, "Dismantling the Pyramid: The Why and How of Privatizing Social Security," the U.S. Social Security system faces an impending crisis. Federal estimates suggest it will be bankrupt in 2030, but the study indicates that could happen by 2014, when baby-boom retirees overwhelm the system.

A pay-as-you-go program, Social Security was flawed from the start, says Tanner. The federal government taxes workers to pay for the benefits of retirees. That may have been fine in 1950, when the worker-to-retiree ratio was an astounding 16-to-1; today, the ratio is 3-to-1. By 2025, it will be less than two workers for every retiree, says Tanner.

What's more, the present system provides returns to workers of just 1 percent per year, even as cost-of-living expenses rise at a rate of 3 percent. "Low-income workers are especially hard-hit," says Tanner. "They need 65 percent to 85 percent of their working wage to retire. Social Security falls short at 44 percent."

Chile recognized the pay-as-you-go dilemma in 1979, the year it instituted reforms, explains Pinera in remarks printed in the Cato Policy Report. The government determined that the minimum contribution of each worker to his or her retirement should be 10 percent of income. It continued to deduct money from each worker's paycheck, but instead of putting it in its own coffers, it turned the cash over to private-sector pension-fund administrators who invested the money in savings accounts, money markets and, later, mutual funds.

Last year, Chile's administrators had money in 20 pension funds, none of which have gone bankrupt, as many skeptics feared, notes Pinera. What's more, annual returns have averaged around 10 percent. In addition, Chile has one of the highest rates of savings in the world, about 26 percent of gross national product, or GNP. Money invested in the pension funds has been used to create new companies and jobs, which resulted in nearly full employment. Economic growth has hovered around 7 percent, double that prior to reform.

"We accomplished a revolutionary reform," writes Pinera, who studied with Nobel Laureate Milton Friedman when the free-market economist taught at the University of Chicago. Pension funds are disbursed to retirees through annuities or in a lump-sum payment. During the transition to the new system, the government incurred costs of about 3 percent of GNP. "We knew that cosmetic changes, increasing the retirement age, increasing taxes, would not be enough."

The Chilean success story has captured the imagination of U.S. policy-makers. Sens. Bob Kerrey, Democrat from Nebraska, and Alan Simpson, Republican from Wyoming, last year introduced a plan to partially privatize Social Security. …