Among the first countries to enact fundamental pension reform was my nation of Chile, the first country in the Western Hemisphere to adopt a social security system, in 1925, 10 years before the United States. But by 1980, when I was Chile’s secretary of labor and social security, its social security system faced the same financial problems as the U.S. system faces today.
Rather than make the usual short‐term fixes of raising taxes or cutting benefits Chile (population, 14.5 million) decided on a revolutionary approach: a privately administered national system of individually owned, privately invested retirement accounts.
The success of Chile’s venture into privatization can provide a valuable example for the United States. After 16 years, Chile’s experiment has proven itself. Pension benefits in the private system already are 50 to 100 percent higher (adjusted for inflation) than they were in the state‐run system. The resources administered by the private pension funds amount to $30 billion, or around 43 percent of GDP as of 1997. Because it has improved the functioning of both the capital and the labor markets, Social Security privatization has been one of the key reforms that has pushed the growth rate of the economy upward from the historical 3 percent a year to 7 percent on average during the last 12 years. The Chilean savings rate has increased to 25 percent of GDP, and the unemployment rate has decreased to around 5 percent since the reform was undertaken.
Under Chile’s privatized system, which is monitored and regulated by the government, neither the worker nor the employer pays a social security tax to the state. Nor does the worker collect a government‐funded pension. Instead, during his working life, he has 10 percent of his wages automatically deposited by his employer each month in his own, individual account. The contribution is not taxed. His pension level is determined by the amount of money he accumulates during the number of years he is working.
A worker may contribute an additional 10 percent of his wages each month, which is also pre‐tax, as a form of voluntary savings. Generally, a worker will contribute more than 10 percent of his salary if he wants to retire early or obtain a higher pension.
A worker chooses one of about 14 private Pension Fund Administration companies to manage his account. Each company operates the equivalent of a mutual fund that invests in stocks and bonds. Investment decisions are made by the managing company. Government regulation sets only maximum percentage limits both for specific types of investments and for the overall mix of the portfolio. In the spirit of the reform, those regulations are to he reduced with the passage of time and as the companies gain experience.
Workers are free to change from one investment company to another. For that reason, there is competition among the companies to provide a higher return on investment, better customer service or a lower commission. Each worker is given a passbook for his account; every three months he receives a statement informing him of how much money has accumulated and how his investment fund has performed. The account bears the worker’s name, is his property, and will be used to pay his old age pension (with a provision for survivors’ benefits).