Peru's Pension Reform

By Carlos Boloña (Cato Institute conference, London, December 1997)

In 1991, when I was minister of finance, Peru was the second country in the world to privatize its pension system. The reason we did so was simple: the system was bankrupt and becoming an unsustainable burden. In short, when you’re in hell, you need to make changes. And it helps to make changes as rapidly as possible.

Since José Piñera is on the panel here today, please allow me one digression before I make a few observations about how best to implement a privatized system. At the time of the reform, the president of Peru was very concerned. He wasn’t convinced that we should privatize the pension system. So we brought José to talk to him, to discuss what privatization had done for Chile. And, of course, José was able to convince him that privatization was in Peru’s best interest. The reform might not have been signed into law without José’s assistance.

Now, I would like to reflect briefly on our experience in Peru. Proponents of privatization must present a very clear message to the workers of their countries. You shouldn’t get bogged down in the macroeconomic aspects of privatization. From my experience, people don’t find those arguments compelling. What they do find compelling—or at least what the workers of Peru found compelling—was the following message: "We want to return your savings to you. The savings are yours and the government has taken them from you and misused them for too long."

You need to have a persuasive national figure—someone who is not seen as beholden to the government, to unions, or to big business—who will really push the reform and inform people that privatization is in their best interest. Do not tax retirement savings. If you’re going to tax anything, tax consumption. One of the problems we encountered when we privatized our system was that we initially taxed savings and, as a result, decreased the number of pension firms that was willing to get involved in the system. Do not close the doors to new entrants. Allow new pension firms to enter the system, and give workers wide discretion over how they invest their money—and with whom.

Do not simply assume that you must have a minimum pension guarantee. We do not have such a guarantee in Peru, and I don’t think that we should. I believe that minimum pensions present a moral hazard problem. If you guarantee someone a minimum pension, you give that person an incentive to invest haphazardly—to place his money in highly risky investments in hopes of huge returns.

Any country that follows such broad guidelines will, I believe, have success. In Peru, retirees are now averaging a 9 percent annual return on their savings. That’s not as high as we would like it to be, but it is certainly higher than it was. Indeed, under the old government-run system, retirees could expect a negative rate of return on their retirement savings.

But, despite such success, we still face another challenge—the final challenge. The final challenge is to allow individuals to move from a forced savings system into a voluntary savings system. I would like to see the people of Peru demonstrate that, as individuals, we can manage our destiny, our future, our pensions, in a much better way than the government can—either directly or indirectly. If we wish to live in a free society—where people are free to live their lives as they wish—that must be our ultimate goal.