President Clinton and the Chilean Model

By José Piñera

Midnight at the House of Good and Evil

"It is 12:30 at night, and Bill Clinton asks me and Dottie: 'What do you know about the Chilean social-security system?'” recounted Richard Lamm, the three-term former governor of Colorado. It was March 1995, and Lamm and his wife were staying that weekend in the Lincoln Bedroom of the White House.

I read about this surprising midnight conversation in an article by Jonathan Alter (Newsweek, M ay 13, 1996), as I was waiting at Dulles International Airport for a flight to Europe. The article also said that early the next morning, before he left to go jogging, President Bill Clinton arranged for a special report about the Chilean reform produced by his staff to be slipped under Lamm's door.

That news piqued my interest, so as soon as I came back to the United States, I went to visit Richard Lamm. I wanted to know the exact circumstances in which the president of the world’s superpower engages a fellow former governor in a Saturday night exchange about the system I had implemented 15 years earlier.

Lamn and I shared a coffee on the terrace of his house in Denver. He not only was the most genial host to this curious Chilean, but he also proved to be deeply motivated by the issues surrounding aging and the future of America. So we had an engaging conversation. At the conclusion, I ventured to ask him for a copy of the report that Clinton had given him. He agreed to give it to me on the condition that I do make it public while Clinton was president. He also gave me a copy of the handwritten note on White House stationery, dated 3-21-95, which accompanied the report slipped under his door. It read:

"Dick-Sorry I missed you this morning. It was great to have you and Dottie here. Here's the stuff on Chile I mentioned. Best, Bill."

Three months before that Clinton-Lamm conversation about the Chilean system, I had a long lunch in Santiago with journalist Joe Klein of Neesweek magazine. A few weeks afterwards, he wrote a compelling article entitled, "If Chile can do it...couldn´t North America privatize its social-security system?" He concluded by stating that "the Chilean system is perhaps the first significant social-policy idea to emanate from the Southern Hemisphere." (Newsweek, December 12, 1994).

I have reasons to think that probably this piece got Clinton’s attention and, given his passion for policy issues, he became a quasi expert on Chile’s Social Security reform. Clinton was familiar with Klein, as the journalist covered the 1992 presidential race and went on anonymously to write the bestseller Primary Colors, a thinly-veiled account of Clinton’s campaign.


“The mother of all reforms”

While studying for a Masters and a Ph.D. in economics at Harvard University, I became enamored with America’s unique experiment in liberty and limited government. In 1835 Alexis de Tocqueville wrote the first volume of Democracy in America hoping that many of the salutary aspects of American society might be exported to his native France. I dreamed with exporting them to my native Chile.

So, upon finishing my Ph.D. in 1974 and while fully enjoying my position as a Teaching Fellow at Harvard University and a professor at Boston University, I took on the most difficult decision in my life: to go back to help my country rebuild its destroyed economy and democracy along the lines of the principles and institutions created in America by the Founding Fathers. Soon after I became Secretary of Labor and Social Security, and in 1980 I was able to create a fully funded system of personal retirement accounts. Historian Niall Ferguson has stated that this reform was “the most profound challenge to the welfare state in a generation. Thatcher and Reagan came later. The backlash against welfare started in Chile.”

But while de Tocqueville’s 1835 treatment contained largely effusive praise of American government, the second volume of Democracy in America, published five years later, strikes a more cautionary tone. He warned that “the American Republic will endure, until politicians realize they can bribe the people with their own money.” In fact at some point during the 20th century, the culture of self reliance and individual responsibility that had made America a great and free nation was diluted by the creation of “an Entitlement State,” reminiscent of the increasingly failed European welfare state. What America needed was a return to basics, to the founding tenets of limited government and personal responsibility.

In a way, the principles America helped export so successfully to Chile through a group of free market economists needed to be reaffirmed through an emblematic reform. I felt that the Chilean solution to the impending Social Security crisis could be applied in the USA.

Once my country Chile had finished its transitIon to democracy and once I had done everything possible to ensure the stability of its free market model and its structural reforms, including my own “educational” presidential campaign in 1993, I decided to dedicate my life to sharing the Chilean Model around the world.

At the same time, at the beginning of 1995, when President Clinton was having midnight conversations about the Chilean Model, I received an extraordinary invitation that would help enormously my fight for America. Ed Crane, Founder and President of the libertarian Cato Institute, invited me to become a Distinguished Senior Fellow and co-chairman of its Social Security Choice Project. I accepted immediately.

In the following years I traveled around the USA sharing the Chilean experience in conferences, town hall meetings, congressional hearings, media interviews, etc. The audiences were extremely receptive and interested, but what Milton Friedman called “the tyranny of the status quo” made it difficult for political leaders to embrace such a new solution to its growing Social Security problem.

However, in January 1996, Mack McLarty, President Clinton's chief of staff, traveled to Chile and wanted to know firsthand about the success of the first private personal accounts system in the world. We met for hours and he quizzed me about both the principles and the details of the system. A few weeks later, I received a letter from him with an enthusiastic message:

“José, Without doubt, the reform of Chile’s pension system has been a critical contributing factor –some have called it the mother of all reforms—to Chile’s ongoing economic success. The social security reforms which you developed and fought for have put your country on a stable footing for the future. Although the Chilean and North American experiences are different in several key respects, I believe we can learn a great deal from your country’s bold initiative, which is widely envied throughout the hemisphere . " ( January 26, 1996)

A letter to the President of the United States

Then, in his January 1998 State of the Union address, President Clinton warned the nation of the coming Social Security crisis and called for an open debate on the needed reforms:

“All the American people who are watching us tonight should be invited to join in this discussion, in facing these issues squarely and forming a true consensus on how we should proceed. We'll start by conducting nonpartisan forums in every region of the country, and I hope that lawmakers of both parties will participate. We will hold a White House conference on Social Security in December. And one year from now, I will convene the leaders of Congress to craft historic bipartisan legislation to achieve a landmark for our generation, a Social Security system that is strong in the 21st century.”

On the heels of this speech, I realized that no momentum could be lost. I needed to reach the President himself. Knowing Clinton’s reputation as a voracious reader, I resolved to write an open letter to the president in a major newspaper, where he was sure to take notice.

And so the following April, at a Tokyo conference organized by the powerful ‘Keidanran,’ the Japanese industrialist association, I broached the idea of my open letter to a fellow speaker, George Melloan of the Wall Street Journal. He told me it was highly unusual for the Journal to publish such a piece, but after reading a draft he enthusiastically accepted. Melloan asked me to send it by fax to the Journal’s America’s columnist Mary O’Grady in New York. With my Cato colleague Bob Borens we were staying in the Imperial Hotel, we spent the whole night exchanging faxes between Tokyo and downtown New York, revising every comma of the draft until we were all fully satisfied.

The letter was published in the editorial page on April 10, 1998. Here is the text:

“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 was labor and social security secretary of Chile in 1980, my country faced the same problem the U.S. now confronts. We decided to save our social security system by converting it from a pay-as-you-go model to individual retirement savings accounts. 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 to convert to individual retirement accounts. But the Chilean example gives many more reasons. In the 17 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 to its lowest levels in history, productivity has increased sharply, the savings rate has soared to around 25% of gross domestic product and economic growth has more than doubled to a 7% average during the last 13 years. If we keep up the present rhythm for another seven years, the size of the economy will have quadrupled in only 20 years.

This is a real economic and social revolution, allowing the country to improve education, health and the environment to a previously unthinkable level. This success has led seven other Latin American countries -- Argentina, Bolivia, Colombia, El Salvador, Mexico, Peru and Uruguay -- to emulate our example in the last five years, and several Central and Eastern European countries, including Russia, are considering similar reforms.

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.

-- First and foremost, policy makers must emphasize the benefits to ordinary citizens. 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 and not only about macroeconomic equilibrium.

-- The public must understand that individual retirement accounts will help the poor. 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 the value of what was their payroll taxes in real assets. Of course, there should still be a safety net provided from general tax revenues.

-- Even though 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% real rate of return compounded over the course of their working lives.

-- Make the reform optional. Give those who are already in the government system the option of staying with 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.

-- Make it absolutely clear that the elderly will not be harmed by the reform. 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.

-- The country should be assured that the transition from the old system can be financed. 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. Budget surpluses present a historic opportunity to begin financing the transition.

-- Take this message to the people. 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.

In his recent 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." 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 global social security crisis is creating the opportunity for a fundamental paradigm shift regarding the role of government in modern societies. Thomas Jefferson once predicted that "the ball of freedom, once set in motion, will roll around the world." Transforming Social Security in this way can be a massive blow against the economic drag of the welfare state that has characterized the 20th century and stifled the creative spirit of mankind for too long. This would be true leadership and become your legacy for all time.”


The White House Summit on Social Security

My expectations were surpassed when I received an invitation from Gene Sperling, domestic policy advisor to the President, to speak at the coming White House Conference on Social Security. The title of the panel, “The Challenges of Social Security Reform: Private Market Options,” symbolized the open mind with which the Administration sought to pursue the notion of individual retirement accounts.

The panel would be presented before an audience coming from all areas of civil society: senior groups, youth organizations, think tanks, labor unions, business leaders and academia. Perhaps more importantly, a bipartisan assortment of 60 members of the House and Senate would be in attendance, along with other officials from the Administration.

The stakes were high. In a press briefing on December 2, 1998, in the week leading up to the White House Conference, Sperling declared that the summit was needed “to derail the third-rail mentality that has often stifled Social Security reform”. He showed a keen awareness of this Carpe Diem moment, declaring:

I think the political realities are that 1999, as an off-election year with a Democratic president in his second term, and a year of focus on Social Security that we have had, offers a unique opportunity to address this, and also with having the strong fiscal situation that we’re in. So I think, in a practical, political sense, one does have to worry that if we do not get Social Security reform done this year, we do not have a good effort, that one does not know when another opportunity will come that is as opportune as this, and one does not know whether many of the resources that would have been available have already been drained elsewhere.”

While I was both honored and humbled to be invited, especially given the fact that I was the only speaker who didn’t possess an American passport, I was at the same time sobered by the inherent challenges of such an address. In just a few minutes, I would need to introduce my prior involvement with Social Security reform in Chile, outline the technical details of the system, and explain why a 1980 economic restructuring in a small, distant nation had relevance to the American way of life.

In many ways, the United States seemed better poised to handle the transition to private retirement accounts in 1998 than my own country did in 1980, and I needed to express these American advantages in my speech. I would attempt to instill confidence that America can confront its social security dilemma, and inspire hope that a better solution was in the offing.

During the inaugural ceremony, I sat down with Pete Peterson, former U.S. Secretary of Commerce, Deputy Chairman of the Federal Reserve Bank of New York, and Chairman of the Blackstone Group. Peterson, whose family emigrated from Greece and who wanted to make a contribution to his new country, had been for years writing and speaking about the coming problem of aging. We had met before to share views on how to advance the reform process. He had stated clearly the stakes in this endeavor when he wrote in Foreign Affairs:

"The costs of global aging will be far beyond the means of even the world's wealthiest nations—unless retirement benefit systems are radically reformed. Failure to do so, to prepare early and boldly enough, will spark economic crises that will dwarf the recent meltdowns in Asia and Russia. For this and other reasons, global aging will become not just the transcendent economic issue of the 21st century, but the transcendent political issue as well."

As the C-SPAN cameras rolled, I delivered the message I had wanted so long to give. If I could not be the architect this time around, at least I could be a postman.

”Ladies and Gentleman, Maybe you have seen “Il Postino”, the beautiful film about Pablo Neruda , my country’s Nobel laureate poet. I come today just as a postman, bringing you not a letter but a message from Chile. The message is that those same five principles that President Clinton mentioned today were applied in my country 18 years ago. This reform can be done because it has been done, and it has worked extremely well for everybody, especially the common worker.

Let me be clear: I do not believe in perfect reforms. We made mistakes, and we should always be open to improving the system. When I was appointed Secretary of Labor and Social Security of Chile in 1978, I accepted because my main concern was to defeat poverty and I was convinced I could made a difference to millions of people who lived lives of quiet desperation. Poverty in young age is terrible, but a young person has a life of opportunity in front of him. Poverty in old age is even worse, especially for a woman who has lost their husband—they not only suffer the pain of losing a beloved person but also the anxiety of not having the benefits to be able to live with dignity.

We began a Social Security system as yours in my country in 1925—ten years before FDR began it in the U.S. In face of the approaching financial bankruptcy of our system in 1980, there were two extreme positions. One was not to change the system, to prolong the agony, to tinker at the edges. The other was to completely dismantle the system and leave everyone alone facing the choices for old age. We chose a centrist way. We chose to save the notion of social security by creating a fully funded system based on individual retirement accounts.

Every Chilean worker has a pension passbook—I always carry one of them. The worker has his money put here in the passbook and they know every month how much money they have. And they accumulate money during all their working life, and in this way we have allowed the working poor to benefit from that extraordinary force of compound interest. They cannot save additional money from their wages because they don’t have that much, so we ask them to put the payroll tax into these passbook accounts. When they reach retirement age, they have huge capital of their own because their money has grown exponentially. At that moment, they cannot withdraw it as a lump sum, and perhaps risk losing it. They have to change it into an annuity that is indexed for inflation and that has to have family provisions in order to take care of the widow or orphans. Or, they can keep the money in the account and make what we call “programmed withdrawals,” in order not to have the risk of changing all the money at a given moment of time.

The real rate of return that I used to explain the new system to Chilean workers was only four percent above inflation, and still the personal accounts system would give a better benefit than the old one. During 18 years, the rate of return has been 11 percent above inflation. So, if you deduct today’s administrative cost of 1.2% of assets managed, it will still give you around ten percent above inflation every year.

While workers like of course a high return, they mainly worry about security. So, we did this revolutionary reform with a very conservative execution. We created a special supervisory board to avoid any fraud. We placed very strict rules for portfolio diversification. For example, this year the stock market has gone down 25 percent because of the Asian crisis, but the return rate of the pension funds in Chile has gone down only 2.5 percent—still having an average over 18 years of 11 percent.

We also instituted a safety net—a guaranteed minimum income to every worker—so when you reach retirement age, you know that you will be able to live with dignity. This is financed by general tax revenues and therefore is very progressive. Second, we asked for a disability insurance taken as a group, not as individuals. In that way, the healthy people can help the disadvantaged. To the elderly, we told Chileans we would not take their grandmother’s check away. We thus guaranteed the benefits of the elderly and indexed them to inflation.

We gave every worker the choice to stay in the old system if they didn’t like this very small element of market risk and preferred the demographic or political risk. Or, they could move to the new system with recognition bonds recognizing their past contributions. 93 percent of Chilean workers have chosen the system of the passbook, rather than the pay-as-you-go system.

We have also given workers the ability to choose pension funds. I believe that workers are smart enough to choose investments, because they have had to survive on very small incomes and they have learned how to choose things close to their lives. The system even gives them a choice of retirement age. They can have voluntary savings so that they can retire before the legal retirement age, and some of them prefer to go on working.

The transition was a complex proposal, but we were able to do it. We kept part of the payroll tax in the pay-as-you-go system in order to finance the elderly benefits. We used the budget surplus as the president is suggesting in this country. And finally, we cut all corporate welfare. We told the private companies that they do not need government money. That money should be used to finance the national retirement system.

So, the reform was not about savings or about macroeconomic equilibrium. It was about workers’ dignity, workers’ freedom, workers’ choice, and workers’ empowerment. I believe this can be done in America.

In Chile, no one was investing in stocks 18 years ago. In your country, you have 40 percent that are already investing in stocks. You have the best capital markets in the world that can diminish risk to a tolerable level. The technological revolution is allowing individuals to manage millions of accounts at negligible costs. And finally, you are such an open-minded country that you have invited a Chilean to be here.

So, I have enormous hope for this country that I love. And I would like my son, who was born in Boston and carries an American passport, to also be able to someday have a pension retirement passbook like this. ”


Sex and Social Security

Two months later, President Clinton said in his January 1999 State of the Union address:

“Our fiscal discipline gives us an unsurpassed opportunity to address a remarkable new challenge: the aging of America. With the number of elderly Americans set to double by 2030, the baby boom will become a "senior boom" …Today, Social Security is strong. But by 2013, payroll taxes will no longer be sufficient to cover monthly payments…The best way to keep Social Security a rock-solid guarantee is not to make drastic cuts in benefits; not to raise payroll tax rates; and not to drain resources from Social Security in the name of saving it…I propose a new pension initiative for retirement security in the 21st century. I propose that we use a little over 11 percent of the surplus to establish universal savings accounts -- USA accounts -- to give all Americans the means to save. With these new accounts, Americans can invest as they choose, and receive funds to match a portion of their savings, with extra help for those least able to save. USA accounts will help all Americans to share in our nation's wealth, and to enjoy a more secure retirement.”

The opening salvo had been fired: “to establish universal savings accounts -- USA accounts.” This was the first time that a sitting president had called for the creation of personal retirement accounts. In my view, this was a huge step forward in the direction of a Chilean-type system of personal retirement accounts, so aptly called by Clinton “Universal Savings Accounts”.

But regrettably it was not to be. Just as Clinton was gearing up to reform Social Security, he found himself unexpectedly mired in the Monica Lewinsky scandal. The affair was a disgraceful event indeed, but it was the process of impeachment of the President that buried the possibility of making this reform at that moment.

So, as encouraged as I felt after this State of the Union address calling for universal savings accounts, the reality quickly set in: the besieged president could not deliver on his proposal, no matter how genuinely he knew the country needed it. As a New York Times editorial asserted the day after his address, “since the Republicans control Congress and the impeachment battle will probably leave a bitter aftertaste, the President’s plans are certain to be more of a conversation opener than a blueprint for the future.” (“The State of the Presidency; Mr. Clinton’s New Agenda,” 1/20/99).

Even though Clinton was acquitted by the Senate and thus allowed to remain in office, the ordeal exhausted both his political capital and his resolve to tackle major reforms. Clinton would not spearhead any major legislation during the remainder of his term. The Social Security time bomb would be passed along to a successor. A vital opportunity had been squandered.

In his book “The Natural. The misunderstood Presidency of Bill Clinton” (2002), Joe Klein, after many hours of conversations with the former President, draws the following conclusion:

The Lewinsky scandal had a powerful, if usually overlooked, impact on the substance of Clinton’s last two years in office as well. When I asked the President what he might have accomplished absent the scandal, he said that he wasn’t sure. When pressed, Clinton acknowledged that he might have been able to reform the Social Security and Medicare systems if the Republicans -and the media-hadn’t been provided with an alternative form of diversion in 1998 and 1999. In fact, Clinton was poised, at the moment he delivered his “Save Social Security First” challenge in the 1998 State of the Union message, to do something few presidents ever had: to end his second term with a valedictory surge of significant accomplishments. He had tamed the Republican Congress. There were huge budget surpluses to play with. “Both parties were behind the curve on the big issues,” said Bruce Reed, Clinton’s domestic policy advisor. “We could have added a private-investment option on to Social Security benefits.”

Other observers concurred. As one of them stated, Clinton sacrificed “an enduring legacy when he had an affair with Lewinsky, the young White House intern. Liberal Democrats were opposed to his pension changes, so to get their support to avoid impeachment, Clinton postponed the package of reforms.” (James Daw, The Toronto Star, September 22, 2002).

A key Clinton Adviser, Douglas Elmendorf, would later write a paper confirming that the possibility existed and that the impeachment destroyed it. It has been reported in this way:

In 1998 President Clinton and his economic advisers spent 18 months secretly discussing the elements of a plan to add individual investment accounts to Social Security, but abandoned it when it became clear the president would be impeached, according to a paper by three former administration officials that will be presented today at a Harvard conference." (Glenn Kessler, Washington Post, June 29, 2001).

As in a Greek tragedy, Clinton’s failure to reform Social Security can be explained in terms of his hamartia or tragic flaw. Clinton was undoubtedly an extremely gifted politician and a very intelligent man, but regrettably he was not a statesman willing to sacrifice earthly pleasures for a lasting legacy. It was proven that he did not belong, in the immortal words of Lincoln, "to the family of the lion, or the tribe of the eagle."

It is astounding how our human imperfections can have unintended consequences of enormous importance. As I traveled back all night to my country in those early months of 1999, knowing full well that though the seed had been planted the flower would not bloom during the Clinton presidency, I kept coming back to the achingly beautiful words that Shakespeare gave Hamlet:

Blest are those
Whose blood and judgment are so well commingled,
That they are not a pipe for fortune's finger
To sound what stop she please. Give me that man
That is not passion's slave, and I will wear him
In my heart's core, ay, in my heart of heart…

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