Commentary

An Open Letter to President Clinton

This article originally appeared in The Wall Street Journal.

Dear President Clinton:

In your state of the union address you called for an open debate on Social Security reform. I wish to respond to that call.

At Georgetown University recently, you publicly recognized that the U.S. Social Security system is going broke. You are right. Like the Titanic, it is heading toward disaster, while some keep insisting that there is no problem.

The truth is that the U.S. has only two options: to prolong the agony of the current system, or as you have said, “to experiment boldly.” But so far only short-term solutions have been proposed. Some have suggested raising the payroll tax, but this would hurt job creation and increase the burden of a regressive tax on low-income workers. Others recommend increasing the retirement age, but that would especially burden blue-collar workers. These half-measures can only buy time. If the ship doesn’t change course, sooner or later you’re going to hit an iceberg – an aging population that cannot be supported by the workforce.

Another Way

There is another way. When I was labor and social security secretary of Chile in 1980, my country faced the same problem the U.S. now confronts. We decided to save our social security system by converting it from a pay-as-you-go model to individual retirement savings accounts. Workers now choose among competing private companies to invest the equivalent of what used to be their payroll taxes in a conservative portfolio of high rated bonds and equities. This allows workers to harness the powerful force of compound interest – reflecting the wealth-creating effect of the market – to ensure their security in retirement.

If empowering the common man – turning every worker into a shareholder – were the only benefit of such reform, that would be reason enough to convert to individual retirement accounts. But the Chilean example gives many more reasons. In the 17 years since Chile embarked on this course, complemented by other important market reforms, a flood of investment has benefited both individuals and the economy as a whole. As unemployment has fallen to its lowest in history, productivity has increased sharply the savings rate has soared to around 25% of gross domestic product and economic growth has more than doubled to a 7% average during the last 13 years. If we keep up the present rhythm for another seven years, the size of the economy will have quadrupled in only 20 years.

This is a real economic and social revolution, allowing the country to improve education, health and the environment to a previously unthinkable level. This success has led seven other Latin American countries – Argentina, Bolivia, Colombia, El Salvador, Mexico, Peru and Uruguay – to emulate our example in the last five years, and several Central and Eastern European countries, including Russia, are actively considering similar reforms.


Thomas Jefferson once predicted that “the ball of freedom, once set in motion, will roll around the world.” Transforming Social Security in this way can be a massive blow against the economic drag of the welfare state that has characterized the 20th-century and stifled the creative spirit of mankind for too long.


Of course there are political challenges that inevitably lie in the path of any important reform – in particular, gaining public support and managing the transition. Let me share with you the lessons I learned from the Chilean experience.

  • First and foremost, policy makers must emphasize the benefits to ordinary citizens. Transforming Social Security into an investment vehicle will boost the wealth of the U.S. economy, as many experts have calculated, but that won’t capture the imagination of voters. The general public must understand that they will benefit from the ownership of wealth through the capital markets, giving them far more independence and freedom. This reform is about citizens’ empowerment and not only about macroeconomic equilibrium.
  • The public must understand that individual retirement accounts will help the poor. High-wage earners can always save for their own retirement. But medium- and lower- income workers don’t have spare cash to save in separate individual retirement accounts; they suffer the most with negligible returns on their Social Security payments. They will gain the most from a system that allows them to invest their payroll taxes in real assets. Of course, there should still be a safety net provided from general tax revenues.
  • Even though the reform is revolutionary, the execution must be conservative. Financial soundness and prudent regulations should be paramount in the design of the new system. Only when people understand that they will not lose their money will they appreciate the joys of, say, an average 6 percent real rate of return compounded over the course of their working lives.
  • Make the reform optional. Give those who are already in the government system the option of staying in it or moving to the new system. Those who move should receive a recognition bond for their past contributions. In this way the new system is not compulsory.
  • Make it absolutely clear that the elderly will not be harmed by the reform. On grounds of both fairness and prudence, I recommend guaranteeing the benefits of the elderly currently receiving Social Security and of those who decide to stay in the government system. That would be a move forward since those benefits are now subject to reduction by political whim.
  • The country should be assured that the transition from the old system can be financed. True, the nation will have to foot the bill for current benefits while payroll tax revenues dwindle. But these expenses are “sunk costs” – they will have to be paid whether the system is reformed or not. When a worker moves out of the government system, payroll tax revenues will decline but so will future liabilities, because that worker will no longer be accumulating rights to further benefits. In the long run the burden on the system will be reduced. Budget surpluses present a historic opportunity to begin financing the transition.
  • Take this message to the people. Political support will be forthcoming if people have good information. A Cato Institute web site already exists (www.socialsecurity.org) that allows one to calculate returns on the government program and comparable returns on equivalent savings invested in the market. Cynics can discount political calculations all they want – mathematical ones are more difficult to ignore.

In his recent testimony before the Senate Budget Committee, Federal Reserve Chairman Alan Greenspan stated that “the general broad principles, which are somewhat similar to the Chilean-type system, strike me as the way in which convergence of opinion is starting to move and a valuable first step in moving toward a solution.” Policy makers must seize the day. The longer they wait, the more difficult change becomes. Every year the unfunded liability expands. Countries that phase out their tax-and-spend social security systems and move towed investment-based schemes become more competitive, with a growing capital base, lower labor costs and, eventually, lower taxes.

Paradigm Shift

The global social security crisis is creating the opportunity for a fundamental paradigm shift regarding the role of government in modern societies. Thomas Jefferson once predicted that “the ball of freedom, once set in motion, will roll around the world.” Transforming Social Security in this way can be a massive blow against the economic drag of the welfare state that has characterized the 20th-century and stifled the creative spirit of mankind for too long. This would be true leadership and become your legacy for all time.

Jos�© Pi�±era is president of the International Center for Pension Reform and co-chairman of the Cato Institute’s Project on Social Security Privatization.