Uneven Benefits Are private investment accounts the way to fix Social Security? Chile's experience highlights the ups and downs.
(Business 2.0) – If you care about your retirement income, keep an eye on Chile. No, I'm not suggesting that you sell your blue chips to buy shares on Chilean markets. Chile matters for one big reason: Its pension system, which is based on individual investment accounts, offers a preview of the model President Bush hopes to implement here at home.
The U.S. Social Security system is in trouble: In a few decades, it won't be able to pay the benefits promised to future retirees without dramatic tax increases. One way to close the gap is by taking advantage of the relatively high returns provided by stock and bond markets. Under the Bush administration's plan, workers would put money into portfolios that they could cash in upon retirement. The benefits paid from these accounts would fluctuate with the market, but in theory they'd offer better returns than the current program.
How much better? Social Security's rate of return is limited by growth in wages and the size of the workforce. But the program guarantees to offset inflation, and in recent years payments have risen between 1 and 3 percent. Over the past half-century, however, a balanced portfolio of stocks and bonds has grown by an annual average of about 5 percent. Yet what matters most is how a retiree would actually fare, day by day, under a system that's far more vulnerable to market turmoil like the plunge that lasted from 2000 to 2002.
This is where Chile's example is a cautionary tale. In 1981 the nation adopted a system of portfolio-based accounts to replace a crazy quilt of more than 100 different pension schemes run by 32 institutions. With the individual accounts, workers can choose from dozens of investment options (much like mutual funds) managed by seven licensed companies. The government sets basic ground rules to protect portfolio yields and security, but fund managers do the rest. Chile's system has many of the qualities Americans would presumably want in an investment-based pension system: flexibility, competitiveness, and reasonably good regulation.
In the past 15 years, Chilean pension portfolios have turned in mixed results. The average annual benefit increase was 2.5 percent for regular retirement accounts and 1.5 percent for early retirement accounts. (Chile treats these separately.) That's about the same yield as the pay-as-you-go American system. Yet there were six years when benefits actually fell. In 1998, for example, Chile's early retirees got 7 percent less than they had received the year before, adjusted for inflation, primarily as a result of the Asian financial crisis; the loss for regular retirees was 4 percent.
What happens when senior citizens lose 7 percent of their purchasing power in a given year? It's the equivalent of almost a full month's spending. Some seniors might have to do without a few luxuries; others would have to cut necessities. This much is certain: If a 7 percent drop occurred in the United States--and our stock market fell by almost as much in 2002 as Chile's did in 1998--the AARP would organize marches on Washington.
Politics aside, potential volatility suggests a more fundamental concern. One of Social Security's functions is to help people plan ahead. If benefits fluctuate, most of us will have to set aside rainy-year funds to prepare for market dips. That's the price of the greater reward, and greater risk, inherent in portfolio accounts. And because they undermine one of the fundamental goals of Social Security--to provide senior citizens with a predictable income--that's exactly why they're a dubious proposition for the United States.
Daniel Altman is a London-based economist and the author of "Neoconomy," a new book about President Bush's economic policy.