August 16, 2016 5:49PM

The Attack on Chile’s Private Pension System

Last month, a scandal erupted in Chile. The media discovered that the former director of the Chilean gendarmerie, the country’s penitentiary service, was receiving a pension of about $8,000 per month. Chile privatized its pension system in 1980. Instead of sending retirement money to the government, workers there put their money in private accounts that invest and accumulate savings to be used in old age. When Chile approved the reform, the military and some law enforcement agencies (such as the gendarmerie) remained in the old public system.

Although the abuse occurred within the old public pension system, which benefits a minority of Chileans, and the beneficiary in this case was a socialist political activist and ex-wife of the head of the lower house of Congress (also a socialist), the episode was used to attack the private system to which almost every Chilean worker belongs. The left declared that the private accounts managed by the private pension fund companies (known by their Spanish acronym AFP) provide low pensions, something that incensed many Chileans who saw that the AFPs do not pay the same level of pension evident in this particular case.

Before long, protests involving hundreds of thousands of people took place throughout the country under the slogan "No + AFP," and demanded a return to the old pension system. Last week, President Michelle Bachelet announced a series of reforms that would give the state a larger role in peoples’ retirement.

The extent to which the campaign against the private pension system relies on deception, falsehoods, and distortions is impressive. The Chilean case matters because it is the model that has inspired reforms in dozens of countries around the world, from Sweden to Hong Kong, and from Peru to Poland. To avoid falling victim to demagoguery, it is important to contrast facts with ill-founded criticisms, something that neither the Chilean AFPs nor many others in the region do well.

Critics in Chile assert that the average pension provided by the private pension fund companies is around $340 per month, which is not better than the public pension system. But as the Chile-based Liberty and Development institute (LyD) has shown, that is like comparing apples to oranges. To calculate the private system’s figures, all those affiliated with it are taken into account, even if they have only contributed to their accounts once in their lifetime. The corresponding figure for the public pension system, however, only takes into account the pensions of those who have contributed for a minimum of 10 to 15 years, something that leaves out half of the people affiliated with that system. In addition, pensions under the private system are obtained through contributions that amount to 10 percent of wages, while in the public system the contribution is 20 percent. Correcting for those distortions shows that the value of the pensions the AFPs provide is three times higher than that of the public system.

To properly evaluate the private system, one has to consider its performance with respect to those who have contributed to it regularly. According to data from AFP Habitat, a pension fund company, the average monthly pension for those who have contributed for more than 30 years is almost $1,000 for men and $500 for women. And while it’s true that many Chileans do not contribute regularly to their retirement accounts because too many work outside the formal sector and getting work is still too precarious for many, that is a problem that affects any pension system, whether public or private, and can only be solved with labor reforms.

Nor is it true that the state has no role in providing pensions or that the AFPs steal from their clients, as is regularly asserted. As LyD Institute reminds us, the state has provided a pension for those who could not save a minimum amount from the beginning. And the fees charged by the AFPs are equivalent to 0.6 percent of funds managed, below the average of OECD countries.

Chile’s private pension system can certainly be improved, but the reality is that it has been extremely successful. Over the course of 35 years, private accounts have produced an average real return of 8 percent annually, and old-age pensions no longer represent a burden on the treasury. Pension savings have reached $168 billion, about 70 percent of GDP, which has stimulated high growth and domestic investment, and has put Chile on the verge of becoming a developed country—a remarkable achievement.