Since the implementation of Mexico's private pension system on July 1, 1997, about 14.5 million Mexican workers have opened their own pension savings accounts. The development implications of this are revolutionary.
The decentralization of pension investments, now flowing into domesticcapital markets, should make Mexico's financial system-which is overlyreliant on troubled banks-more efficient and democratic. Bolsteringfinancial-sector stability prior to next year's presidential election ishighly relevant, especially if Mexico is to avoid the financial turmoilthathas accompanied each transfer of power since 1976. Just as importantly,thenew pension system is on track to empower Mexicans as never before.Indeed,the savings deposited in pension accounts already amount to almost $15billion and are expected to grow to $25 billion by the end of next yearandto $138 billion by 2015.
Yet despite this rosy prognosis, financial stability and old-age securityremain far from certain. The government is well aware of the potentialforinstability next year and thus has signed a $24 billion agreement withtheInternational Monetary Fund and other multilateral lenders to "bulletproof"the economy. Yet a far better way to insulate the country from the riskoffinancial meltdown is to forge ahead with structural reforms, and inparticular pension reform. Such reform would also move Mexicans one stepcloser to retirement well being.
In a document submitted to the IMF on June 15, Secretary of Finance AngelGurria and Governor of the Bank of Mexico Guillermo Ortiz addressedpensionliberalization. "The government plans to relax investment restrictions by(1) allowing the private pension funds to invest more in private sectorinstruments and (2) allowing private pension fund managers to offer morethan one fund (with varying degrees of risk)." While this is a goodstart,they should do more.
The liberalization of investment rules to allow the pension-fundadministrators (known by the Spanish acronym Afores) to invest in bondsandequities-at home and, especially, abroad-is the most urgent reform. Atpresent, the Afores must invest a minimum of 65% of workers' savings ingovernment instruments and are barred from investing abroad. Therequirementto invest in government bonds is at odds with the notion of pensionprivatization, where individuals acting in the private sector have thepowerto make their own investment choices. International diversification wouldreduce risk and help preserve the purchasing power of workers' savings incase of inflation or a sharp depreciation of the currency.
To avoid conflicts of interest, the framers of the pension privatizationlawgave the National Pension Savings Commission the role of setting andenforcing rules. And yet the Instituto Mexicano de Seguridad Social(IMSS),the government agency that administered the former system, still enforcessome regulations. It also competes as an Afore, collects industry-widedataand all pension contributions, provides life and disability insurance,anddistributes pension benefits to a variety of workers.
There are many reasons why the IMSS should remove itself from pensionmanagement, not the least of which is the fact that the director of theIMSSsits on the commission's board. And there is no justification for theIMSS'sinsurance role, which is expensive and inefficient. In fact, the onlyrolethe IMSS should have is to administer the pensions generated under thepublic system, which is slowly being phased out. It already has its handsfull running health care and unemployment insurance, which are yet to beprivatized.
Another set of problems with the privatized system is that the governmentstill distorts the incentives of market participants. The currentarrangement allows transition workers (i.e., those who contributed to theIMSS before the new system was implemented) to choose upon retirement thepension system (old or new) that will give them the higher level ofbenefits. This "life-time switch" option poses a moral hazard. It alsomakesthe total cost of the transition more difficult to calculate sinceworkershave an incentive to take high risks in their own accounts, knowing theycanalways fall back on the benefits of the government system.
Likewise, the government's "social contribution" to every worker'saccountweakens the link between effort and rewards, a major flaw of any publicsystem. Furthermore, any contribution paid out of government revenues issubject to political pressure and increases the temptation toward fiscallaxity.
Currently workers must deposit 5% of their wages-or 43.5% of their totalsocial security contribution-to a housing account administered by agovernment housing-credit agency known by the Spanish acronym Infonavit.Unfortunately Infonavit has been operating in the red in recent years,andinvestments are almost guaranteed to have a negative rate of return. Theforced Infonavit contribution is therefore not only counter-productivebutalso discouraging for savers.
In the interest of fairness, all public-sector workers should be giventhechoice of joining the new private system. Otherwise, portability losses-anAchilles' heel of the old system-will remain and might severely punishworkers who move to work in the private sector.
Finally, the rules on market share-each Afore is limited to 17% of thetotalmarket, 20% in 2001 -- should be eliminated. If there are economies ofscale, those rules increase inefficiencies and, consequently, increasecostsborne by investors. More importantly, such limits could deny someinvestorsthe freedom to choose their preferred Afore.
It will not be easy for President Ernesto Zedillo to reform pensionregulations at this late date. Campaign politics are certain to produceopposition to even the most reasonable proposals. But a successfulpensionprivatization requires the right incentives. Thus, in order to leave alegacy of stability Mr. Zedillo should use his remaining time in officetowork at reform as his government promised to do two years ago and againlastmonth at the signing of the IMF agreement.
For the first time in history Mexican workers have a chance to save forfreedom and economic security in old-age. Mr. Zedillo has an opportunitynotonly to help them achieve that goal but also to take a giant step towardputting an end to the financial debacles that have marked the end of eachpresidential term since 1976.