The decentralization of pension investments, now flowing into domestic capital markets, should make Mexico’s financial system-which is overly reliant on troubled banks-more efficient and democratic. Bolstering financial-sector stability prior to next year’s presidential election is highly relevant, especially if Mexico is to avoid the financial turmoil that has accompanied each transfer of power since 1976. Just as importantly, the new pension system is on track to empower Mexicans as never before. Indeed, the savings deposited in pension accounts already amount to almost $15 billion and are expected to grow to $25 billion by the end of next year and to $138 billion by 2015.
Yet despite this rosy prognosis, financial stability and old-age security remain far from certain. The government is well aware of the potential for instability next year and thus has signed a $24 billion agreement with the International Monetary Fund and other multilateral lenders to “bullet proof” the economy. Yet a far better way to insulate the country from the risk of financial meltdown is to forge ahead with structural reforms, and in particular pension reform. Such reform would also move Mexicans one step closer to retirement well being.
In a document submitted to the IMF on June 15, Secretary of Finance Angel Gurria and Governor of the Bank of Mexico Guillermo Ortiz addressed pension liberalization. “The government plans to relax investment restrictions by (1) allowing the private pension funds to invest more in private sector instruments and (2) allowing private pension fund managers to offer more than one fund (with varying degrees of risk).” While this is a good start, they should do more.
The liberalization of investment rules to allow the pension-fund administrators (known by the Spanish acronym Afores) to invest in bonds and equities-at home and, especially, abroad-is the most urgent reform. At present, the Afores must invest a minimum of 65% of workers’ savings in government instruments and are barred from investing abroad. The requirement to invest in government bonds is at odds with the notion of pension privatization, where individuals acting in the private sector have the power to make their own investment choices. International diversification would reduce risk and help preserve the purchasing power of workers’ savings in case of inflation or a sharp depreciation of the currency.
To avoid conflicts of interest, the framers of the pension privatization law gave the National Pension Savings Commission the role of setting and enforcing rules. And yet the Instituto Mexicano de Seguridad Social (IMSS), the government agency that administered the former system, still enforces some regulations. It also competes as an Afore, collects industry-wide data and all pension contributions, provides life and disability insurance, and distributes pension benefits to a variety of workers.
There are many reasons why the IMSS should remove itself from pension management, not the least of which is the fact that the director of the IMSS sits on the commission’s board. And there is no justification for the IMSS’s insurance role, which is expensive and inefficient. In fact, the only role the IMSS should have is to administer the pensions generated under the public system, which is slowly being phased out. It already has its hands full running health care and unemployment insurance, which are yet to be privatized.
Another set of problems with the privatized system is that the government still distorts the incentives of market participants. The current arrangement allows transition workers (i.e., those who contributed to the IMSS before the new system was implemented) to choose upon retirement the pension system (old or new) that will give them the higher level of benefits. This “life-time switch” option poses a moral hazard. It also makes the total cost of the transition more difficult to calculate since workers have an incentive to take high risks in their own accounts, knowing they can always fall back on the benefits of the government system.
Likewise, the government’s “social contribution” to every worker’s account weakens the link between effort and rewards, a major flaw of any public system. Furthermore, any contribution paid out of government revenues is subject to political pressure and increases the temptation toward fiscal laxity.
Currently workers must deposit 5% of their wages-or 43.5% of their total social security contribution-to a housing account administered by a government housing-credit agency known by the Spanish acronym Infonavit. Unfortunately Infonavit has been operating in the red in recent years, and investments are almost guaranteed to have a negative rate of return. The forced Infonavit contribution is therefore not only counter-productive but also discouraging for savers.
In the interest of fairness, all public-sector workers should be given the choice of joining the new private system. Otherwise, portability losses- an Achilles’ heel of the old system-will remain and might severely punish workers who move to work in the private sector.
Finally, the rules on market share-each Afore is limited to 17% of the total market, 20% in 2001 — should be eliminated. If there are economies of scale, those rules increase inefficiencies and, consequently, increase costs borne by investors. More importantly, such limits could deny some investors the freedom to choose their preferred Afore.
It will not be easy for President Ernesto Zedillo to reform pension regulations at this late date. Campaign politics are certain to produce opposition to even the most reasonable proposals. But a successful pension privatization requires the right incentives. Thus, in order to leave a legacy of stability Mr. Zedillo should use his remaining time in office to work at reform as his government promised to do two years ago and again last month at the signing of the IMF agreement.
For the first time in history Mexican workers have a chance to save for freedom and economic security in old-age. Mr. Zedillo has an opportunity not only to help them achieve that goal but also to take a giant step toward putting an end to the financial debacles that have marked the end of each presidential term since 1976.
