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A lesson on pensions from Chile

Posted by Richard on April 27, 2005

QandO’s Dale Franks blogs about a NY Times op-ed column by John Tierney. Tierney visited an old friend in Chile and compared his Social Security "pension" with the Chilean privatized system’s. It’s not even close. For about the same "set-aside" of 12% of income (which includes disability insurance), the Chilean system would provide Tierney with about triple the income, and that’s assuming below-market returns for the Chilean mutual fund in which his friend is invested. Interesting comparison.

I have a quibble with Franks, though. He closes with (emphasis added):

Private accounts do not address the coming funding/solvency problems with Social Security. But one can’t help but note that the return is far better than Social Security offers.

Too many people who should know better keep repeating this nonsense about private accounts not fixing the solvency problem. Of course they do!

When you offer young workers a private account that they own and that provides triple the "return on investment" of the present system, then you’re in a position to dramatically reduce their future entitlement to Social Security dollars as a completely reasonable and fair tradeoff. 

In fact, it would be insane to let workers divert part of their Social Security taxes to a private account without reducing their future Social Security entitlements. The reduction need not be just proportional to the diversion, since the funds diverted to a private account produce both a greater income and an owned asset. In other words, if you let workers divert 1/3 of their Social Security taxes (or about 4%), you can reduce their future Social Security benefits by significantly more than 1/3, and they’ll still be far better off.

That reduction in future liabilities certainly does address the solvency problem. And if we were properly accounting for those future liabilities today, there wouldn’t be all this nonsense about "transition costs" either. If you think that switching to private accounts imposes transition costs, it’s because you’re not currently tallying the future liabilities that Social Security incurs.

Every additional dollar you need today (to replace the dollars going to private accounts) means more than a dollar that you won’t need tomorrow (because of the dollars from private accounts). It’s just a timing issue, and those are easily solved: you borrow what you need today and pay it back with what you save tomorrow. The first part of that seems to come so easily to our political leaders; it’s only the second part that’s new.

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One Response to “A lesson on pensions from Chile”

  1. Chileno said

    The problem with Chilean social security is that people are so poor here that they can’t end up saving much anyway. It’s not a functional system, and shouldn’t be viewed as anything exemplary.

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