For a true pension reform
3 de octubre de 2016

About the author

José Piñera, a life promoting reforms

Born on October 6, 1948 in Santiago de Chile, José Piñera Echenique is one of the most influential liberal intellectuals in the world. Considered the father of the private pension system that has been adopted by dozens of countries either totally or partially, Piñera chairs the International Center for Pension Reform and is Distinguished Scholar at the CATO Institute. José Piñera completed his higher education as an economist at the Catholic University of Chile and then moved to the United States where he pursued graduate studies. He holds a Master and a Ph.D. degree in Economics from Harvard University. In 1975 he returned to Chile and started working to promote economic and political modernization in his country.

Piñera was Minister of Labour and Social Welfare between 1978 and 1980. He then took over the Mining Department, between 1980 and 1982. During those years that followed, he was essential for the recovery of freedom in Chile. Piñera developed several reforms that opened up the economy, but he also promoted peaceful return to democracy by writing dozens of articles in defense of political liberties and human rights.

Since the introduction of these reforms, Chile’s per capita GDP has soared from $5,000 to $23,000 US dollars, while the poverty rate has fallen from more than 50 percent to less than 8 percent. Over the past three decades, Piñera has travelled the world promoting structural reforms of the pension system. The alternative to the pay as you go model, which is proving to unsustainable, encompasses the introduction of a fully funded system based on savings. Under Piñera’s model, each worker contributes 10 per cent of his salary to a fund of their own ownership, in which your savings will grow for decades thanks to the magic of compound interest. Therefore, each worker becomes an owner of capital and is able to plan for retirement, choosing at what age he will stop working and choosing between conservative or risky financial products, according to his own criteria.

José Piñera has written numerous books and essays that have strengthened the spread of liberal ideas throughout the world. In Spain, he drafted a pensions reform proposal in the 1990s and more recently, in 2014, he returned to Madrid as keynote speaker of a Civismo conference where he highlighted the importance of reforms for Spain.

A true pension reform for Spain

Sometimes I ask jokingly if the shield of my beloved Spain reads “it can’t be done”. Because that is exactly what many respond when speaking about the Chilean pension system. When it comes to this model, most Spaniards listen with great interest, they formulate intelligent questions, they applaud with enthusiasm, they recognise that it is the best system… but pessimism triumphs in the end, because it is believed that “it can’t be done” in Spain.

My experience tells me the opposite. I am convinced that it is always possible to develop any public policy that is correct, honest and designed to benefit the vast majority of a country. That does not mean that it is easy to implement deep, structural reforms. On the contrary, all the easy things have already been done. So perhaps there is nothing as beautiful and noble in life than setting new goals that are challenging, but achievable.

We are here to discuss what many call the “brain drain”. The first thing we should do is to recognise that this is a natural phenomenon that should always be explained in line with the rising international mobility of labour. At the end of the day, this is simply another expression of human freedom. Everyone has the right to choose where to live and where they work … and I think the world is better insofar as there is greater freedom of movement.

However, in the case of Spain, we must acknowledge that the decision to leave is not always taken freely. After all, unemployment has climbed as high as 25 percent while youth unemployment has surpassed the 50 percent mark. Therefore, those who leave are not only seizing new opportunities, but also escaping the lack of alternatives in their own country.

To solve this problem, we must go to the root of the matter. Sure, there are many public policies that can and should be improved: labour market reform, institutional reform… But there is a structural problem in the Spanish economy: the fact that its welfare state is anchored in a pay as you go pension system that weakens the incentives that encourage people to work and save. The focus is on pressuring politicians for obtaining higher benefits, which ultimately weakens the work ethic.

The pay as you go pension system was born in nineteenth century Prussia by Chancellor Otto von Bismarck, who initially conceived it as a limited program. However, his model came with an original sin: it destroyed the link between contributions to the system and payments obtained from the system, separating effort from reward.

When Bismarck created this model, Prussians had a life expectancy of 45 years yet pensions were only paid once you reached 65 years of age. So this was a mechanism designed for a very small group of people, only the eldest in Prussian society. Political dynamics led to the extension of the system throughout Europe, America and the rest of the world. As a result, the culture of freedom and personal responsibility has been weakened, thus leaving the pay as you go system on the wrong side of history.

Due to its inherent lack of sustainability, the rules of the pay as you go system are changed again and again. Promises are broken, calculation rules are changed, retirement aged is increased regularly, Social Security contributions become higher… If a company did that, we would openly talk about its insolvency. Therefore, we must take the same approach when we talk about the pay as you go pension system. This model leads inexorably to an impoverishment of retired Spaniards.

This aggravates the “brain drain” and demographic trends show that the longterm outlook is even worse. Spaniards have fewer children and live longer years. Therefore, it is time to accept that we need to abandon the old pension system instead of prolonging the agony of a program that is structurally flawed. If the problem is the disconnect between effort and benefit, then we must move gradually to a fully funded, capitalization model. The essence of the reform is to rebuild the link between effort and reward, between contributions and benefits.

Such a system exists in Chile since 1980 and works very well. The Chilean worker sends 10 per cent of his salary to a personal savings account for retirement that receives these contributions on a monthly basis. That money is not saved under a mattress: it is invested safely and responsibly, with diversification and always according to the preferences of the worker, who has the ability to opt for conservative or risky investment strategies, depending on his preferences. An additional 10 percent can be added on top, for those workers who perhaps want to want to work harder, save more money and enjoy a better pension. But the key is that benefits depend on your effort and do not rely on political decisions.

With a system like this, each worker becomes a saver, an owner of capital and a long term investor who accumulates wealth for 40 or 45 years and benefits from compound interest. The growth of his fund for old age is exponential, which frees workers from political power. The system even allows you to retire early, as opposed to the pay as you go paradigm, in which the retirement age is dictated uniformly by the government. And, obviously, there is a basic solidarity pillar that guarantees a minimum level for the poorest pensioners, a program that is paid for via regular taxation.

Dozens of countries have emulated Chile, acknowledging the importance of personal responsibility and individual freedom. This ideas have an immense power. In more than three decades, accumulated savings of Chilean workers have benefitted from a real rate of return of more than 8 per cent. We have transformed every worker into an owner of capital, we have broken the curse of the worker that Karl Marx once described, we have encouraged savings and we have laid the foundation for strong economic growth while avoiding the debt crisis that all pay as you go pension systems are generating.

As globalization develops, turning to this type of model will become hard to resist. The “brain drain” is a good example of how the labour market is changing around the world. Also, the rise of emerging economies may lead the West to decay if no structural reforms are introduced in its broken welfare state.

In the end, instead of seeing talented people “fly away” from Spain, what we need to do is to “fly Spain away from Bismarck” and say goodbye to the pay as you go pension system. Bismarck once withdrew his troops from Paris, but his philosophy still lives in Paris, in Rome, in Madrid… and it is leading European countries into bankruptcy!

Spain can make changes if it commits to reform. We are talking about a rich country with a monumental history, and a privileged geography. Spain has wonderful cities, a great cultural heritage and a modern economy. The problem is that all this is not reflected in public policies for retirement. And that’s what needs to be changed. Prudently, but with conviction.

The mother of all reforms

Each May 1st marks a new birthday for the successful Chilean pension system. Three achievements are indisputable: the system has not suffered any case of corruption or mismanagement; the workers’ savings managed by the Administrators of Pension Funds (AFPs) have yielded a real return of over 8 percent annually; and the system has had a crucial effect in increasing investment, developing markets and spurring greater growth.

With pay as you go pension systems, retirement rules are influenced by the electoral game, thus leading to an accumulation of promises that are ultimately impossible to keep. As a result, benefits are increased in spite of the structural imbalances that they may imply, and the burden of inevitable adjustments is passed to future governments. Professor Deepak Lal has argued that “the creation of gigantic redistributive programs in the West has unexpected consequences such as the corruption of public debates, which are now based on a political struggle to win votes with other people’s money”.

Chile pioneered a system that solves this problem by establishing a defined contribution model that is based on personal accounts for retirement. Savings are administered by private funds and the role of politicians becomes secondary, since government is relegated to playing a subsidiary role. The creation of this model was one of the comprehensive economic, social and political reforms that allowed Chile to rise again after suffering its worst crisis in the 1970s.

The impact of this new pension system goes beyond the impressive indicators that show how Chile’s economic development has accelerated: the reform also led to a radical redistribution of power from the state to civil society. By turning workers into owners of capital, we created a system that is more consistent with the principles of a free and open society.

The Chilean system also led to a global revolution of pensions. More than 30 countries in Latin America, Europe and Asia have followed this path. Hundreds of millions of workers have become owners of capital under this new paradigm, which is also becoming a central element of the debate for reform in developed countries.

I have devoted my life to this intellectual battle and will continue to do so and tour the world in order to bring this pioneering experience to many more workers and families. For, as Lord Tennyson wrote in these verses:

It is not too late to seek a newer world.
To sail beyond the sunset, and the baths
of all the western stars, until I die.
We are not now that strength which in old days
moved earth and heaven.
We are one equal temper of heroic hearts,
made weak by time and fate,
but strong in will
to strive, to seek, to find,
and not to yield.

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