Commentary

Two Cheers for Mexico’s Pension Reform

While Mexico City’s historic first-time mayoral elections are grabbing the headlines these days, a quieter but more revolutionary change is set to kick off on July 1: the privatization of the Mexican social security system.

The system, known by its Spanish initials, IMSS, covers about 10 million Mexican workers and is bankrupt. Its expenditures (which have more than doubled in the past decade), mismanagement of funds and the inherently untenable nature of pay-as-you-go retirement schemes have destroyed its very foundations.

Beginning July 1, Mexican workers will deposit their pension savings in their own accounts. These will be managed by competing private pension fund companies, known as afores, which will invest the money in the capital markets. From July 1 on, social security will be based on individual sovereignty, not some abstract notion of solidarity.

The IMSS privatization—probably the Zedillo administration’s most important reform thus far—differs from previous Mexican privatizations because, at least in theory, it does not intend to generate revenue for the state. Instead, it seeks a laudable goal, admittedly one that politics already appear to be compromising: turning Mexico into a country of property-owning workers. In Mexico this is a revolutionary concept, but you wouldn’t know it from listening to President Zedillo’s technocratic explications. The reform, he argues, will raise the rate of national savings, increase the efficiency of investments and reduce the country’s dependence on foreign finance. Lost in his dry rhetoric is the fact that this is an unprecedented opportunity for Mexicans to determine their own financial destinies.

It should not be surprising, then, that ordinary Mexicans don’t quite understand how the reform relates to their own lives. Indeed, the administration has charged no prominent official with introducing the reform and explaining it to the public. That is a shame, since the central message—”you, not the government, will benefit from the money you make”—is one most Mexicans would eagerly welcome. Meanwhile, the powerful Finance Ministry is running an ominous ad campaign warning individuals to “pay taxes, not the consequences.” Nobody ever accused Mr. Zedillo of public relations savvy.

Perhaps the most significant aspect of the Mexican reform is that it ends the old pay-as-you-go system, as did the Chilean model on which it is based. Implemented properly, that change removes the possibility that old-age savings and benefits may again be politically manipulated. Detractors argue that if the government continues to provide benefits to current retirees, and all workers covered under the current system move into the private system, the reform will be an added drag on an already strained federal budget.

But with or without change, Mexico is obliged to pay benefits to current retirees. The reform merely forces acknowledgment of unfunded liabilities, estimated to be about 80% of gross domestic product. In terms of future growth, fiscal expenditures and national savings, the costs of not switching to a fully funded system far exceed the supposed costs of transition, estimated at about 0.5% of GDP in 1997.

One way of funding the transition, at least in part, is through privatization of government-owned enterprises. Following the Chilean example, the afores themselves could participate in the process, which would effectively transfer the ownership of state enterprises to the country’s workers—the closest thing to voucher privatization in Latin America. Unfortunately, the Zedillo administration has been reluctant to take that course, choosing instead to finance the move from general revenues.

Despite its promise, the new Mexican system will not be as pure or as depoliticized as Chile’s. For example, IMSS will operate its own afore. It will also be in charge of auditing other afores and enforcing compliance within the system. The conflict of interest is glaring. Moreover, the government-backed afore could at some point engage in unfair competition by finding ways to draw on the state’s seemingly limitless coffers and surpass the 17% market share limit that is supposed to apply to all afores.

Also troubling is the new “social contribution,” paid into the pension accounts by the government, equal to 5.5% of the minimum wage. By weakening the link between workers’ contributions and their benefits, that innovation reintroduces a flaw of the old system and opens the door to fiscal irresponsibility. After all, rarely has the Mexican private sector been shy about appropriating public revenues in the name of social welfare; we should not expect the afores to behave any differently.

It appears that the afores will be restricted, at least in the initial years, to placing most of their clients’ money in Mexican government securities—a strategy authorities portray as conservative, essential for ensuring confidence in the new system. Memories of the 1994 peso devaluation should make one wary of such claims. Concentrating retirement contributions in one set of instruments, especially Mexican government bonds, is a reckless investment approach. If the new pension system is viewed as just another way of funding the government, then the reform will hardly represent major change. Fortunately, the administration plans to permit more investments in the private sector in coming years. Only then can pension privatization live up to its promises and working Mexicans benefit from more diversified portfolios.

Unfortunately, the government will prohibit pension fund companies from investing abroad. Afores will literally have no way to hedge against the risk of another national economic crisis. Rather than be held hostage to the performance of the national market, workers should be allowed to seek security in the global market. Under that scenario, Mexicans’ sensitivity to poor government policies would quickly express itself in the market, amounting to yet another novel concept for the country: an effective form of accountability.

Mexico’s pension reform will not solve all of the country’s problems. For one thing, it leaves untouched the larger fiscal problem created by the public health administration, also a part of IMSS. Deregulation, lower taxes and institutional certainty are needed to make the new system pay off (there are, after all, good reasons why Mexican savings and investment rates are not already higher). But pension privatization in Mexico is a paradigm shift every bit as important as pursuing free trade with the U.S. Mr. Zedillo should improve the reform’s technical aspects and stress its revolutionary attributes.

Ian Vásquez is director of the Project on Global Economic Liberty at the Cato Institute.