In Praise and Criticism of Mexico’s Pension Reform

April 14, 1999 • Policy Analysis No. 340

The privatization of Mexico’s government‐​run pay‐​as‐​you‐​go social security system, which went into effect in July 1997, is the Ernesto Zedillo administration’s most important structural reform. It is a measure that, if successful, will help bring much‐​needed social and economic stability. The Mexican peso crisis of 1994–95 underscored the fragility of Mexico’s economy, its need for independent institutions, and its need for a large pool of long‐​term domestic savings. An increase in the rate of private savings in Mexico, which this reform will promote, would make the Mexican economy less dependent on short‐​term fluctuations of international capital flows and, thus, more stable. More important still, the privatization of social security will erect one of the basic pillars of a free society by turning Mexico into a country of property‐​owning workers.

The private system, however, has several structural flaws that should be corrected in the near future if it is to provide workers with the right incentives. Chief among those flaws is the requirement to invest a minimum of 65 percent of workers’ savings in government instruments, a rule that is not consistent with the notion of pension privatization. Other flaws include prohibiting investment in equities or abroad; allowing the government agency that administered the old pay‐​as‐​you‐​go system to establish a pension fund company while retaining some regulatory functions; prohibiting public‐​sector workers from joining the new private system; and having the government subsidize every worker’s retirement account, a measure that politicizes the private pension system and weakens the link between individual efforts and rewards.

President Zedillo should use his remaining time in office to strengthen the new pension system so that Mexican workers can enjoy financial security and other benefits in their old age.

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