Empowering Workers: The
Privatization of Social Security
A specter is haunting the world. It is the specter of bankrupt government-run Social Security systems. The pay-as-you-go system that reigned supreme through most of the 20th century has a fundamental flaw, one rooted in a false conception of how human beings behave: it destroys, at the individual level, the link between contributions and benefits—in other words, between effort and reward. Whenever that happens on a massive scale and for a long period of time, the final result is disaster.
Two exogenous factors aggravate the consequences of that flaw: the global demographic trend toward decreasing fertility rates and medical advances that are lengthening life. As a result, fewer workers have to support more and more retirees. Since increasing payroll taxes generates unemployment, sooner or later promised benefits have to be reduced, a telltale sign of a bankrupt system. Whether benefits are reduced through inflation, as in most developing countries, or through legislation, the result is the same: anguish about old age is created, paradoxically, by the inherent insecurity of an unfunded “Social Security” system.
In Chile, the Pension Reform law of 1980 introduced a revolutionary innovation. The law gave every worker the choice of opting out fully from the government-run pension system and instead putting the former payroll tax in a privately managed personal retirement account (PRA). Since 95 percent of the workers chose the PRA system, the end result was a “privatization from below” of Chile's Social Security system.
Originally published as Cato's Letters no. 10, 1996.