NIALL FERGUSON ON CHILE’S SOCIAL SECURITY REFORM: “THE MOST PROFOUND CHALLENGE TO THE WELFARE STATE IN A GENERATION. THATCHER AND REAGAN CAME LATER”

(Excerpts from the book “The Ascent of Money. A financial history of the World”, by Niall Ferguson, Penguin Books, 2008, pp. 212-219.)

The most radical measures, howewer, would come from a Catholic University student who had opted to study at Harvard, not Chicago. What he had in mind was the most profound challenge to the welfare state in a generation. Thatcher and Reagan came later. The backlash against welfare started in Chile.

For Jose Piñera, just 24 when Pinochet seized power, the invitation to return to Chile from Harvard posed an agonizing dilemma. He had no illusions about the nature of Pinochet’s regime. Yet he also believed there was an opportunity to put into practice ideas that had been taking shape in his mind ever since his arrival in New England. The key, as he saw it, was not just to reduce inflation. It was also essential to foster that link between property rights and political rights which had been at the heart of the successful North American experiment with capitalist democracy.

There was no surer way to do this, Piñera believed, than radically to overhaul the welfare state, beginning with the pay-as-you-go system of funding state pensions and other benefits. As he saw it: “What had begun as a system of large-scale insurance had simply become a system of taxation, with today’s contributions being used to pay today’s benefits, rather than to accumulate a fund for future use. This ‘pay-as-you-go’ approach had replaced the principle of thrift with the practice of entitlement ... [But this approach] is rooted in a false conception of how human beings behave. It destroys, at the individual level, the link between contributions and benefits. In other words, between effort and reward. Wherever that happens on a massive scale and for a long period of time, the final result is disaster .”

Between 1979 and 1981, as minister of labour (and later minister of mining), Piñera created a radically new pension system for Chile, offering every worker the chance to opt out of the state pension system. Instead of paying a payroll tax, they would put an equivalent amount (10 per cent of their wages) into an individual Personal Retirement Account, to be managed by private and competing companies known as Administradora de Fondos de Pensiones (AFPs)… By the end of 2006, around 7.7 million Chileans had a Personal Retirement Account; 2.7 million were also covered by private health schemes, under the so-called ISAPRE system, which allowed workers to opt out of the state health insurance system in favour of a private provider. It may not sound like it, but — along with the other Chicago-inspired reforms implemented under Pinochet — this represented as big a revolution as anything the Marxist Allende had planned back in 1973.

It is a sign of Chile’s success that the country’s pension reforms have been imitated all across the continent, and indeed around the world. Bolivia, El Salvador and Mexico copied the Chilean scheme to the letter. Peru and Colombia introduced private pen­sions as an alternative to the state system. Kazakhstan, too, has followed the Chilean example. Even British MPs have beaten a path from Westminster to Piñera’s door.

The irony is that the Chilean reform was far more radical than anything that has been attempted in the United States, the heartland of free market economics. Yet welfare reform is coming to North America, whether anyone wants it or not.