Open Letter to President Clinton

(Wall Street Journal, April 10, 1998)

Dear President Clinton:
In your state of the union address you called for an open debate on Social Security reform. I wish to respond to that call.

At Georgetown University recently, you publicly recognized that the U.S. Social Security system is going broke. You are right. Like the Titanic, it is heading toward disaster, while some keep insisting that there is no problem.

The truth is that the U.S. has only two options: to prolong the agony of the current system, or as you have said, "to experiment boldly." But so far only short-term solutions have been proposed. Some have suggested raising the payroll tax, but this would hurt job creation and increase the burden of a regressive tax on low-income workers. Others recommend increasing the retirement age, but that would especially burden blue-collar workers. These half-measures can only buy time. If the ship doesn’t change course, sooner or later you’re going to hit an iceberg – an aging population that cannot be supported by the workforce.

There is another way. When I became Labor and Social Security Secretary of Chile in 1978, my country faced the same problem the U.S. now confronts. We decided to save our social security system by giving every worker the choice to move from a pay-as-you-go model to one of personal retirement accounts. (Coincidentally, you may like to know that this law was approved on November 4, 1980, the same day Ronald Reagan was elected President of the U.S.) Workers now choose among competing private companies to invest the equivalent of what used to be their payroll taxes in a conservative portfolio of high rated bonds and equities. This allows workers to harness the powerful force of compound interest - reflecting the wealth-creating effect of the market - to ensure their security in retirement.

If empowering the common man - turning every worker into a shareholder - were the only benefit of such reform, that would be reason enough give the choice of personal retirement accounts. But the Chilean example gives many more reasons. In the 21 years since Chile embarked on this course, complemented by other important market reforms, a flood of investment has benefited both individuals and the economy as a whole.
As unemployment has fallen, productivity has increased sharply, the savings rate has soared, and economic growth more than doubled to a 7% annual rate. This was a real economic and social revolution, allowing the country to improve education, health and the environment to a previously unthinkable level.

Of course, there are political challenges that inevitably lie in the path of any important reform - in particular, gaining public support and managing the transition. Let me share with you the lessons I learned from the Chilean experience.

· It is about people, not numbers. The country should be assured that the transition from the old system can be financed. Transforming Social Security into an investment vehicle will boost the wealth of the U.S. economy, as many experts have calculated, but that won't capture the imagination of voters. The general public must understand that they will benefit from the ownership of wealth through the capital markets, giving them far more independence and freedom. This reform is about citizens' empowerment, not only about macroeconomic equilibrium.

· The main winners are the poor, not the rich. High-wage earners can always save for their own retirement. But medium and lower-income workers don't have spare cash to save in separate individual retirement accounts; they suffer the most with negligible returns on their Social Security payments. They will gain the most from a system that allows them to invest their payroll taxes in real assets. Of course, there should still be a safety net provided from general tax revenues.

· The reform is revolutionary, the execution must be conservative. Financial soundness and prudent regulations should be paramount in the design of the new system. Only when people understand that they will not lose their money will they appreciate the joys of, say, an average 6 percent real rate of return compounded over the course of their working lives.

· Free to choose. Give those who are already in the government system the option of staying in it or moving to the new system. Those who move should receive a recognition bond for their past contributions. In this way the new system is not compulsory.

· Do not take away grandmothers'checks. On grounds of both fairness and prudence, I recommend guaranteeing the benefits of the elderly currently receiving Social Security and of those who decide to stay in the government system. That would be a move forward, since those benefits are now subject to reduction by political whim.

· It can be done! True, the nation will have to foot the bill for current benefits while payroll tax revenues dwindle. But these expenses are "sunk costs" - they will have to be paid whether the system is reformed or not. When a worker moves out of the
government system, payroll tax revenues will decline but so will future liabilities, because that worker will no longer be accumulating rights to further benefits. In the long run the burden on the system will be reduced.

· We the People. The whole American experience has been built trusting the common sense and the values of the people. Educated people cannot be demagogued. Give them the facts. Give them the arguments. Reach them through TV, radio, and print. Leverage the new frontiers opened by the internet. Political support will be forthcoming if people have good information. A Cato Institute web site already exists ( that allows one to calculate returns on the government program and comparable returns on equivalent savings invested in the market. Cynics can discount political calculations all they want - mathematical ones are more difficult to ignore. This could be an immensely popular reform, and personal retirement accounts could become the "third-rail" of American politics.

· Carpe Diem. Policy makers must seize the day. The longer they wait, the more difficult change becomes. Every year the unfunded liability expands. Countries that phase out their tax-and-spend social security systems and move toward investment-based schemes become more competitive, with a growing capital base, lower labor costs and, eventually, lower taxes.

The best minds of your country are behind this idea, including three of the most distinguished Nobel laureates in economics: Milton Friedman, Gary Becker, and James Buchanan. Moreover, in his testimony before the Senate Budget Committee, Federal Reserve Chairman Alan Greenspan stated that "the general broad principles, which are somewhat similar to the Chilean-type system, strike me as the way in which convergence of opinion is starting to move and a valuable first step in moving toward a solution."

Mr. President, the global social security crisis is creating the opportunity for a fundamental paradigm shift regarding the role of government, not only in your country, but also in Europe, Russia, Japan and China. One of your most distinguished predecessors, Thomas Jefferson, once predicted that "the ball of freedom, once set in motion, will roll around the world." Transforming Social Security in this way would demonstrate true leadership and become your legacy for all time.

José Piñera
Former Secretary of Labor and Social Security in Chile.



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