by José Piñera (International Center for
- [article published on the Wall Street Journal in 1998]
If you wish to copy, reproduce or
reprint please check our Permissions
On the wall of my office in Santiago, Chile, I have a map
of the Americas with South America's sharp southern tip pointing
toward the top and the United States and Canada at the bottom.
Visitors often look puzzled, then exclaim, "Oh, they've
hung your map upside down."
"No," I say, "it's just a different way of
looking at the world." I often think of that map when
I'm asked how Europe's crisis-riddled pension systems can
Reform is possible, I reply, if people are willing to look
at the world in a different way. Most importantly individuals
will need more power to provide for their own retirement -
and the government's role must be scaled back. We've accomplished
this in Chile, and reform on the Chilean model is being seriously
considered in the United States. In the meantime, the system
has already spread to several other nations around the globe.
Beneath its veneer of egalitarianism, Europe's present pension
systems are hideously unfair to tens of millions. Most young
workers can look only to paying more and more to support those
on retirement today - and then to receiving less and less
when they themselves retire. Many under-40 members of today's
working population may end up on income support to make ends
meet in the next few decades, even though they pay up to 20%
or more of their income in social security taxes.
Part of the problem is demographics. Europe's state pension
systems are based on the so-called pay-as-you-go (Paygo) principle,
meaning that the pension payroll taxes of today's working
populations are passed through immediately to today's retirees.
This system worked half-a-century ago in a world where there
were seven or more workers for each retiree, who typically
lived only a few years after he left the work force.
That world is gone. Thanks to a sharply declining birth rate
and longer life expectancy, there are now an average of only
four people of working age to support each pensioner in the
15 member states of the European Union. By 2040 there will
be only two, and in some countries like Germany the ratio
of workers to pensioners will be closer to one to one.
As a result, the financial burdens will become enormous. Pension
contributions in Germany, for example, are now 20.3% of earnings,
and the government has just increased VAT to finance the cost
of pensions. And that is just the beginning. In France, pension
contributions may have to double to 40% of earnings. But higher
payroll taxes lead to even higher unemployment and thus fewer
contributors to the pension system.
At the same time, the payouts will be trimmed. European governments
have already begun doing so, for example, by increasing the
retirement age. Meanwhile, every pressure group wants to cut
the best deal for its members. Thus we see that Italian civil
servants retire in their early 50s and that French truck drivers
can end their working lives at 55. Does anyone seriously believe
that such a system can survive in the 21st century?
Twenty years ago my country faced a similar crisis. Chile
had created a state pension system in 1925 and by the 1970s
it was on the brink of bankruptcy, rife with special privileges
and burdened by high payroll taxes.
When I was appointed minister of labor and social security,
my team and I hit upon a simple, yet radical way to keep the
idea of a national retirement system, but change the way it
is structured. Every worker's payroll taxes, we proposed,
could go into a private, individual pension account that would
be his own property. His money would be invested in professionally
managed funds of stocks and bonds. If he changed his job,
his retirement accounts would move with him. These would fuel
- and keep up with - a growing economy, yielding a far better
pension income than if the same sums went to the government.
Here's how the Pension Savings Account (PSA) system works.
To start with, every working man and woman gets a PSA passbook
to keep track of how much has accumulated and how well the
investment fund has performed.
To manage these growing assets, individuals choose freely
among a number of private companies that invest in a diversified,
low-risk portfolio of stocks and bonds. Since workers can
change freely from one company to another, they compete to
provide better customer service and lower commissions. Many
have user-friendly computer terminals where individuals can
calculate the value of their pensions or find out how much
to deposit in order to retire at a given age. The companies
are regulated by the government and there's also a safety
net: the state guarantees a minimum pension if the worker's
savings fall short.
The PSA system changes the very notion of what a pension
is. For example, Chile no longer has a rigid legal retirement
age. People can retire whenever they want, as long as they
have sufficient savings in their accounts for a "reasonable
pension" (50% of average salary of the previous 10 years,
as long as it is higher than the minimum pension). If they
want to, they can continue working without contributing to
the plan after their pension begins. No longer is anyone forced
to leave the labor force - or work on the black market - because
he draws a pension.
Today Chile's private pension system has accumulated an investment
fund of some $30 billion, in a country of only 14 million
people and a gross domestic product of only $70 billion. As
University of California economist Sebastian Edwards noted,
the system "has contributed to the phenomenal increase
in the country's savings rate, from less than 10% in 1986
to almost 29% in 1996." Chilean people have reaped a
rich harvest. The average worker has earned 12% annually after
inflation, and pensions today are much higher than under the
old system, nearly 80% of annual income over the last 10 years
of working life.
Can this system work in Europe? Some economists assert that
it can't. Let's examine their objections.
"1"The transition to an investment-based system
is too costly."
If today's worker's taxes get redirected into individual retirement
funds, critics wonder, who will pay the pensions of today's
retired workers? In Chile, we covered the guarantees to already
retired workers in several ways. The government issued new
bonds, which spread some of the cost over the generations.
Privatization of state-owned business, and a reduction in
government spending elsewhere, were also important. We levied
a small temporary transition tax; and the economic growth
unleashed by the PSA system brought in greater overall tax
In the meantime, during the transition, everyone contributing
to the old system could remain in it, but those who moved
had their rights to partially accrued pension income guaranteed
by the government. All new entrants to the work force were
required to go into the PSA system.
"2"Operating costs of an investment-based system
True, professional pension fund managers do have advertising
and investment costs that tax-and-spend government programs
run by civil servants do not incur. But the costs are low
- and are dwarfed by the higher returns the PSA system generates.
"3"Private pensions are less reliable and safe."
In fact, it's hard to consider the present setup reliable,
with governments increasing taxes and decreasing payouts.
The investment results of private funds cannot be guaranteed.
But all studies of past performance show that the long-term
gains of a well-chosen portfolio of bonds and equities have
been far greater than that of Paygo systems. The government
supervises the investment companies, and of course the fund
managers themselves keep a constant watchful eye on the accounts.
The PSA system has other benefits. For example, if this system
were adopted Europe-wide, workers would not risk losing their
pension rights if they left a job in one country for a job
in another. Interestingly, the EU Commission is considering
a change from Paygo to an investment-based retirement system
for its own workers.
Harvard University economist Martin Feldstein has estimated
that the value of future benefits to the American economy
of privatizing Social Security pensions could reach an astounding
$20 trillion. "It is difficult to think of any other
policy," he recently wrote, "that could produce
such a substantial permanent rise in the standard of living
of the vast majority of the population." Europe could
also derive a similarly huge benefit.
I cannot emphasize enough that the PSA is not a solution
of the political right or left; it empowers all workers. It
allows them ownership of financial capital that many have
never had, giving them a greater stake in the economy than
ever before. It may seem revolutionary to suggest that Europeans
give up their dependence on the state for their old-age livelihood
in favor of taking their pension provision into their own
hands. Nevertheless, millions of people in countries such
as Peru, Argentina, Colombia, Bolivia, El Salvador, and Mexico
have already done so, with excellent results for themselves,
their economies and their societies.
To all who say it cannot be done, my reply is twofold: it
has been done, and - considering the ruinous state of Europe's
pensions financing - it must be done.
the Article in PDF Format
If you do not have the required "Adobe
Reader" you can download it for free from the Adobe.com
website by clicking on the following icon: