Social Insecurity: Lessons of Social Security Reform from Abroad

By Newmyer, Jacqueline | Harvard International Review, Fall 1998 | Go to article overview

Social Insecurity: Lessons of Social Security Reform from Abroad


Newmyer, Jacqueline, Harvard International Review


In a meeting last year with Ohio Governor George V. Voinovich, Chilean economist Jose Pinera offered this challenge to the United States: "You won the arms race. Let's see whether you can also win the pension race."

In an age of lengthened life expectancies and escalating ratios of retirees to workers, efforts are underway to revamp state retirement benefits programs around the world. As the US Social Security system, which uses the revenue from current payroll taxes for benefits payments to current retirees approaches insolvency, reformers are increasingly turning their attention to foreign models of pension privatization. In answering President Clinton's call for a national debate on the future of Social Security, policy-makers would do well to consider foreign approaches.

Chile converted from a pay-as-you-go system similar to US Social Security to a privately administered system of individual retirement accounts in 1981. Over the last seventeen years, the South American nation has seen a remarkable rise in its savings rate, which has in turn boosted overall productivity growth. One of the most impressive statistics is Chile's 12 percent average real return on investment (payroll taxes). While US workers can expect to receive a meager two percent rate of return from the government, which does not invest Social Security intakes, Chileans are raising their nation's capital stock by collecting large windfalls from equity investments.

Under the Chilean plan, employers automatically deposit ten percent of a worker's wages in an individual account. This contribution goes untaxed, and a worker may choose to inject as much as an additional ten percent, pre-tax, into his account. The key to the empowerment of the worker, however, is his involvement in the investment of his assets through the selection of a management fund. Fourteen private companies, Asociacion de Fondos de Pensiones (AFPs), dominate the market from which workers choose. The AFPs, however, are subject to government regulation, limiting the range of investments in their portfolios. According to Pinera, who designed the Chilean pension system while serving as the country's labor and social security secretary, even these regulations will gradually be phased out.

The flexibility granted to workers under the Chilean program extends to the collection of benefits. At retirement, a worker can decide either to use his personal account funds toward the purchase of an annuity from a private life insurer, or to make fixed withdrawals of an amount determined by his life expectancy and those of his dependents. This design offers a high degree of individual tailoring to participants and thus raises the efficiency of the entire system.

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Social Insecurity: Lessons of Social Security Reform from Abroad
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