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Give Workers a Free Choice

by José Piñera

This article appeared on cato.org on January 27, 1997.

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More young Americans believe in UFOs than believe they will receive a Social Security check when they retire. Among other things, this is a terrible indictment of a government program that has run its course.

When Otto van Bismarck created pay-as-you-go social security in 1883, he never dreamed that most governments in the Western world would adopt his model - and that a century later all those systems would be heading toward bankruptcy. The absurdity of the pay-as-you-go system is comparable to that found in the works of Franz Kafka, whose days working at a social security institution must have been a source of inspiration. Suffice it to say that all over the world, social security administrators must be having nightmares about biotech breakthroughs like DHEA that may allow more and more people to celebrate their 100th birthday. In a way, these are also nightmares about a sort of metamorphosis, though not into giant insects.

The system could survive longer if people had more babies, since younger generations finance the pensions of the old. But the opposite is occurring in all rich countries - including the United States.

I come from a distant country, one the Spanish conquerors initially named Finis Terrae (Land's End). But in these days of a global village, I can bring you an idea, a powerful idea, that can save social security by privatizing its provision. We tried this idea in Chile 16 years ago. See "Empowering Workers: The Privatization of Social Security in Chile" At age 30, I became minister of labor and social security in Chile and, with a team of young and creative people that I assembled to devise the reform, we did not ask "Why?" but rather, as Bobby Kennedy had urged, "Why not?"

Indeed, why not the best social security system for all workers? Not only for the ones with the extra cash to buy private retirement insurance, but also for those who could not afford to save because of onerous taxes. We came up with a simple idea: allow each worker to put their payroll tax into an individual pension savings account (PSA), where they could keep an eye on their money (or, as we say in Spanish, "la plata donde mis ojos la Bean"). These funds would be invested in real wealth producing activities; of course, not all the eggs would be put in the same basket. And so workers would have capital of their own when they retire. The entire system would be managed by private enterprises in a highly competitive market (no barriers to entry, no initial advantages to established banks or financial institutions).The PSAs would be portable so workers could move them to another company.

Perhaps the most difficult task was to devise a workable transition to the new system. We set three rules: "Do not hurt your grandmother" (guaranteeing benefits to those already retired);"Give workers a free choice" (offering the option of staying in pay-as-you-go or opting out voluntarily); and "Do not accumulate more debt for your grandchildren" (closing the door of pay-as-you-go for young new entrants). We also devised responsible ways of financing that sunk cost without increasing tax rates.

The results? Today 9 out of 10 workers are in the PSA system. They have received an average return rate of 12 percent above inflation during 15 years. The whole issue has been depoliticized and civil society strengthened. The economy, not surprisingly, has also benefited: more savings (Chile has a savings rate of 27 percent of GNP), higher productivity of capital (invested through markets), and more employment since the tax on the use of labor has been eliminated (the unemployment rate is 5.5 percent). Ultimately, higher growth and more opportunities for everyone.

Joe Klein - although not anonymously - came to Chile in 1994 to see whether all this was true. Upon his return to the United States, he wrote an article titled "If Chile Can Do It ..." for Newsweek. "The Chilean system," he wrote, "is perhaps the first social policy idea to emanate from the Southern Hemisphere." If my eldest son, born in Boston and carrying an American passport, comes to work here in the future, perhaps he will be able to transfer his pension fund from a Chilean PSA to an American PSA.

This article originally appeared in Wired Magazine.