Chile's private system of individual retirement accounts, adopted in 1981, is based on three important pillars: freedom of choice, private-sector management, and property rights in the retirement accounts. In its 18 years, that system has been an enormous success: more than 95 percent of Chilean workers have joined the system; the pension funds have accumulated over $33 billion in assets; and the average real rate of return has been 11.3 percent per year.
If imitation is the sincerest form of flattery, the Chilean system should be blushing from the accolades it has received. Since 1993 seven other Latin American nations have implemented pension reforms modeled after Chile's. In March Poland became the first country in Eastern Europe to implement a partial privatization reform based on the Chilean model. In short, the Chilean system has clearly become the point of reference for countries interested in finding an enduring solution tot he problem of paying for the retirement benefits of aging populations.
Chilean workers are retiring with better, more secure pensions and, increasingly, at early ages. For instance, since the early retirement option was introduced in 1988, the average monthly pensions for workers retiring early have ranged from $258 (in 1989) to $318 (in 1994). By comparison, the representative worker in the United States retiring at age 62 receives monthly benefits that range from $506 to $743 under Social Security. That is an indication of the efficiency of the private system in Chile, not just in comparison with the old Chilean government-run social security system, but also in comparison with the government-run system in the United States, a country where per capita income is more than five times higher than in Chile. Chilean workers who retire at 65 are also getting benefits that are higher relative to per capita income than the benefits U.S. workers get under Social Security.
Through their pension accounts, Chilean workers have become owners of the means of production in Chile and, consequently, have grown much more attached to the free market and to a free society. This has had the effect of reducing class conflicts, which in turn has promoted political stability and helped to depoliticize the Chilean economy. Pensions today do not depend on the government's ability to tax future generations of workers, nor are they a source of election-time demagoguery as they are in the U.S. Instead, pensions depend on a worker's own efforts and thereby afford workers satisfaction and dignity.
Critics of the Chilean system often point to high administrative costs, lack of portfolio choice, and the high number of transfers from one fund to another as evidence that the system is inherently flawed and inappropriate for other countries, including the United States. Some of those criticisms are misinformed. For example, administrative costs are about 1 percent of assets under management, a figure similar to management costs in the U.S. mutual fund industry. To the extent the criticisms are valid, they result from a single problem: excessive government regulation.
The commissions workers pay fund managers are heavily regulated by the government. Commissions must equal a certain percentage of contributions regardless of a worker's income, which prevents fund managers from adjusting the quality of their service to the ability (or willingness) of each segment of the population to pay for that service. Other rules cover the return on investments made, subjecting funds to a government-mandated minimum return guarantee (a fund's return cannot be more than 2 percentage points below the industry's average real return in the last 12 months). That regulation forces the funds to make very similar investments and, consequently, have very similar returns.
Despite the overabundance of regulations, the primary ingredients for the system's success -- individual choice, clearly defined property rights in contributions, and private administration of accounts -- have survived. If Chilean authorities address some of the remaining shortcomings with boldness, Chile's private pension system should be even more successful in its adulthood than it has been during its first 18 years. American reformers would do well to study this track record when considering the future of our own retirement system.