Bring on the Chilean Pension Reform

[Editorial, Wall Street Journal Europe, December 23, 1997]

In an interview with the Chilean newspaper La Tercera earlier this month, Russian Deputy Prime Minister Boris Nemtsov noted that "Russians only know Chilean wines and juices." Soon they may get a taste of another Chilean specialty -- private pensions.

Last week, the Russian government approved an overhaul of the ailing state pensions scheme with a plan that would combine state and privately funded pensions. Details are sketchy, but it appears that the current generation of workers will be provided for under the existing state pension system. The government will try to encourage Russians to work longer by tying pensions more closely to time served on the job and indexing pensions to wage levels. Presumably, new hires would fall under a new, privately funded system.

After the Russian parliament's rough handling of tax reform, it's hard to be optimistic about pension privatization. Given the season, though, we prefer to note the growing number of countries that have embarked on such reforms -- and the comparative advantage Russia and its ex-communist neighbors have in privatizing pensions.

What was once called the Chilean model -- after the revolutionizing Chilean pension reform of 1980 -- might now better be referred to as the Latin American model.

Indeed, Argentina, Peru, Columbia, Uruguay, Mexico and Bolivia all have variations on Jose Piñera's Chilean privatization.

Currently 26 million workers in Latin America have chosen private pensions, accumulating $44 billion in assets. According to Citibank estimates, by 2000 there will be another four million private pension fund clients and those assets will more than double to $91 billion.

Closer to home, Russia might take note of pension reforms underway across Central Europe, where aging populations and pension costs of up to 15% of GDP have made social security reform an urgent necessity. Both Poland and Hungary quickly discovered that the kinds of stop-gap measures favored in Bonn or Brussels do little good. Both countries are tackling the problem with pension reform modeled largely after the World Bank's 1994 "multipillar" prescription for a basic state pension topped out with both mandatory and voluntary payments into private investment funds.

Kazakhstan and Latvia are well on their way to putting in place pension reforms similar to those in Poland and Hungary and comprehensive programs for funded pensions have already been approved in Romania, Slovenia, the Czech Republic and Croatia. We might quibble with the still too significant role given the state in the World Bank's prescription -- and with some of the restrictions placed on the new funds in countries where it is applied. But these funded systems are a vast improvement over state systems in which taxes paid by workers are simply transferred to retirees.

Most of Western Europe, meanwhile, is busy sticking band-aids on taxed-as-you-go systems, despite unfunded pension liabilities totaling more than 100% of GDP in countries such as Italy and Belgium. It is, of course, only a matter of time before these systems collapse. In nearly every Western European country (Ireland is the notable exception), the ratio of workers supporting retirees is shrinking because of low birth rates. By 2030 it is estimated that every worker will be supporting a retiree.

There are real economic benefits to a system such as Chile's Pension Savings Accounts, which helped spur higher economic growth and real wages by accelerating capital formation. Less noticed are the political and psychological benefits as an entire sector of the population obtain visible property rights and a personal stake in the economy.

Last week's Russian announcement is but a baby step. But as with other East European states, the need is urgent as the state finds itself unable to provide for aging populations. More fundamentally, reform governments benefit from an unlikely source: public distrust in government solutions. East Europeans are increasingly willing to put their faith in the market; ironically, the opposite of what you find in Western Europe, where skepticism of the market goes hand-in-hand with an abiding faith in government-as-protector. But don't bet that Western Europe will not soon find itself pressed to follow the lead of the East.