Piñera on the Chilean Model

July 23, 2002

Investor's Business Daily on July 15 interviewed Jose Piñera, architect of Chile's system of personal retirement accounts and co-chair of Cato's Social Security project. Excerpts follow.

IBD: What moved Chile to privatize its pension system?

Piñera: The structural flaws of the state-run, pay-as-you-go system: the aging of the population, the political manipulation and the constant pressure for special-interest legislation.

IBD: What obstacles did privatization face?

Piñera: Our biggest challenge was educational: we had to dig the country out from under the weight of collectivist ideas, ideas that had been assimilated, admittedly, under the guise of good causes. As with much of the Hispanic world, there had long been a widespread distrust of private enterprise and free markets.

IBD: Was it tough to finance the switch?

Piñera: Of course it was, but I can assure you that it is easier to transfer passengers from one ship to another ship before crashing into an iceberg than after. We showed it could be done without raising taxes or cutting benefits to the elderly.

IBD: How has the privatized program fared in the past two decades?

Piñera: It's been successful beyond all my dreams. Even though offered as voluntary to participants in the old system, 95% of workers today have personal retirement accounts. At the time it was done, enrollment estimates ranged from zero to at most 50%. Also, even though it was initially explained to the workers assuming a 4% real rate of return, it has been, in real terms, 10.7% annually on average during the first 21 years. And there have been great economic externalities: higher savings, better productivity of capital and ultimately a much higher growth rate of the economy.

IBD: Is fraud a problem with the privatized system?

Piñera: No. Thanks to rules about portfolio diversification, maximum transparency and a rigorously set-up system of government regulation and supervision - including the creation of a highly technical and depoliticized superintendency - never in 21 years has there been a fraud like Maxwell's in the U.K. or, it seems, Enron's in America.

IBD: Is there any sentiment in Chile for returning to the old system?

Piñera: Despite heavy criticism at its creation, three successive center-left governments have fully embraced it and even made technical adjustments fully in line with the system's basic philosophy. The new system of personal retirement accounts is now the real "third rail" of Chilean politics.

IBD: How does the future look for the system?

Piñera: My only worry about the new system is that I always thought of it as needing fine-tuning with time. Those changes have been coming, but too slowly, due to complacency and inertia.

IBD: You've compared Social Security in the U.S. to the Titanic. Why?

Piñera: Because Social Security is the biggest government-spending program in the U.S. and in the world. It has an annual expenditure of approximately $400 billion, almost a fourth of the federal budget. And it is heading directly towards an iceberg - the demographic trends that lead to an increasingly aging population. That not only entails the bankruptcy of the pay-as-you-go system - that's the visible part of the iceberg - it also reduces to confiscatory levels the rate of return to current and especially future workers - the big, hidden part of the iceberg.

IBD: Could a Chilean-style system work in America?

Piñera: Of course. And even better. The essence of the Chilean retirement model is that each worker saves money during his or her lifetime to finance his or her needs in old age. If you take into account that global demographic trends make the pay-as-you-go system unsustainable, and given the huge development of capital markets, which allow capital accumulation at compound interest and with multiple ways of risk-diversifying, I think that a system of personal retirement accounts is the solution for the 21st century. If Americans, Italians or Japanese, etc., do not procreate enough they will have to save sufficient dollars, euros or yen in retirement accounts to pay for their old age.

IBD: What is the mission of Cato's privatization project?

Piñera: To think the previously unthinkable: transform the unfunded Social Security system into a funded one in which every American can invest their (Social Security) taxes in a personal retirement account that is their property and cannot be politically manipulated. We produce books, articles, and papers making a rigorous case for this solution. We have a Website, www.socialsecurity.org , with a calculator showing the benefits of the new system to individuals.

IBD: How long can the U.S. wait before it must act to reform its Social Security system?

Piñera: The sooner the better, because the closer the Titanic is to the iceberg the more difficult it will be to maneuver and either change course or begin transferring the passengers. If President Bush has two terms, I strongly believe he will do it and, as Roosevelt did, leave a legacy of winning a war and addressing what may be the most important domestic problem of the country.

For more information on Chile's reform, see "Empowering Workers: The Privatization of Social Security in Chile," by Jose Piñera. For information on how the Chilean model has fared over time, see "Chile's Private Pension System at 18: Its Current State and Future Challenges," by Jacobo Rodriguez.

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