Social Security, part 4
Since the President's cited Chile's privatized pensions scheme as a model for his Social Security overhaul, now would be a good time to check in and see how that's been working out for them.
Meanwhile, an article in the LA Times outlines the genesis of this latest scheme, and Paul Krugman pokes yet another hole in the administration's phony math.
It really is that stark: any growth projection that would permit the stock returns the privatizers need to make their schemes work would put Social Security solidly in the black.
Meanwhile, an article in the LA Times outlines the genesis of this latest scheme, and Paul Krugman pokes yet another hole in the administration's phony math.
It really is that stark: any growth projection that would permit the stock returns the privatizers need to make their schemes work would put Social Security solidly in the black.
posted by Management at 11:24 PM
3 Comments:
The New York Times
January 27, 2005
Chile's Retirees Find Shortfall in Private Plan
By LARRY ROHTER
SANTIAGO, Chile - Nearly 25 years ago, Chile embarked on a sweeping experiment that has since been emulated, in one way or another, in a score of other countries. Rather than finance pensions through a system to which workers, employers and the government all contributed, millions of people began to pay 10 percent of their salaries to private investment accounts that they controlled.
Under the Chilean program - which President Bush has cited as a model for his plans to overhaul Social Security - the promise was that such investments, by helping to spur economic growth and generating higher returns, would deliver monthly pension benefits larger than what the traditional system could offer.
But now that the first generation of workers to depend on the new system is beginning to retire, Chileans are finding that it is falling far short of what was originally advertised under the authoritarian government of Gen. Augusto Pinochet.
For all the program's success in economic terms, the government continues to direct billions of dollars to a safety net for those whose contributions were not large enough to ensure even a minimum pension approaching $140 a month. Many others - because they earned much of their income in the underground economy, are self-employed, or work only seasonally - remain outside the system altogether. Combined, those groups constitute roughly half the Chilean labor force. Only half of workers are captured by the system.
Even many middle-class workers who contributed regularly are finding that their private accounts - burdened with hidden fees that may have soaked up as much as a third of their original investment - are failing to deliver as much in benefits as they would have received if they had stayed in the old system.
Dagoberto Sáez, for example, is a 66-year-old laboratory technician here who plans, because of a recent heart attack, to retire in March. He earns just under $950 a month; his pension fund has told him that his nearly 24 years of contributions will finance a 20-year annuity paying only $315 a month.
"Colleagues and friends with the same pay grade who stayed in the old system, people who work right alongside me," he said, "are retiring with pensions of almost $700 a month - good until they die. I have a salary that allows me to live with dignity, and all of a sudden I am going to be plunged into poverty, all because I made the mistake of believing the promises they made to us back in 1981."
With many Chileans finding themselves in a situation much like that of Mr. Sáez, people are still looking to the government, not private pension funds, to ensure a secure retirement.
"It is evident the system requires reform," the minister of labor and social security, Ricardo Scolari, said in an interview here. Chile's current approach based on private pension funds has "important strengths," he said, but "it is absolutely impossible to think that a system of this nature is going to resolve the income needs of Chileans when they reach old age."
In formulating proposals in the United States for individual accounts, advocates of partial privatization of Social Security have sought to overcome some of the problems in Chile. They have suggested, for example, setting low limits on the fees that fund managers will be allowed to charge and continuing to provide a major part of retirement income through the traditional system of guaranteed payments.
The program in Chile differs from the voluntary model that President Bush is considering. Participation here has been not voluntary for people entering the labor force since 1981.
On the other hand, Chile was careful before it started its private system to accumulate several years of budget surpluses, in contrast to the recent large deficits in the United States.
The Chilean example also makes clear that introducing private accounts does not solve a lot of the problems faced in the United States, Europe and Japan, where pay-as-you-go systems remain the principal means of government retirement support.
Over all, Chile has spent more than $66 billion on benefits since privatization was introduced. Despite initial projections that the system would be self-sustaining by now, spending on pensions makes up more than a quarter of the national budget, nearly as much as the spending on education and health combined.
Faced with the likelihood of the gap remaining as it is or, as Mr. Scolari said, "perhaps even widening," the Chilean government is contemplating a new round of pension changes. Suggestions that have been floated include many also under consideration in the United States and Europe, like reducing benefits or setting a higher retirement age.
The problems have emerged despite what all here agree is the main strength of the privatized system: an average 10 percent annual return on investments. Those results have been achieved by the pension funds largely through the purchase of stocks and corporate and government bonds - investments that helped fuel an economic expansion giving Chile the highest growth rate in Latin America over the last 20 years.
"The great success of the system is its high profit rate, more than double what was initially projected," said Guillermo Arthur Errázuriz, executive director of the Association of Pension Fund Administrators. "In total, workers have set aside nearly $61 billion, which is invested in the sectors of the economy that show the most potential."
Among the admirers of the privatized system here is Mr. Bush, who on a visit in November called Chile "a great example" for other countries. On other occasions, he has suggested that the United States could "take some lessons from Chile, particularly when it comes to how to run our pension plans."
The main architect of the Chilean system is José Piñera, who was labor and social security minister from 1978 to 1980 during the Pinochet dictatorship. Mr. Piñera is now chairman of the International Center for Pension Reform, co-chairman of the Cato Institute's Project on Social Security Choice, and he has been a board member of several Chilean corporations.
Mr. Piñera declined repeated requests to be interviewed for this article. In an article on the Op-Ed page of The New York Times last month, though, he extolled the Chilean system as one based on ownership, choice and responsibility and one that is widely popular because it gives workers a stake in the economy.
Among other achievements emphasized here by advocates of the privatized funds are the creation of a modern capital market, cheaper credit for companies that formerly could turn only to banks when they wanted to expand, and a brake on deficit spending by the government.
Critics respond that the privatized system has been less successful in ensuring a dignified retirement for the elderly.
"What we have is a system that is good for Chile but bad for most Chileans," said a government official who specializes in pension issues and who spoke on condition of anonymity, fearing retaliation from corporate interests. "If people really had freedom of choice, 90 percent of them would opt to go back to the old system."
Among the complaints most often heard here is that contributors are forced to pay exorbitant commissions to the pension funds. Exactly how much goes to such fees is a subject of debate, but a recent World Bank study calculated that a quarter to a third of all contributions paid by a person retiring in 2000 would have gone to pay such charges.
But most Chileans are unaware of how much they are paying to the funds because the lengthy quarterly financial balance sheet they receive "is not comprehensible," according to Guillermo Larraín, director of the Superintendency of Pension Funds, a government agency. "It needs to be replaced by a simple and transparent financial statement," he said, so workers can determine which fund charges the lowest fees.
In recent years, the number of pension funds has been winnowed to 6 from a high of 22 in the early 1990's. They have enjoyed record earnings, so much so that foreign banks and insurance companies are investing in the industry. While the pension fund association puts the average annual return on assets just under 30 percent, government figures show profits of 50 percent in 2000, with some independent studies suggesting the funds did that well over the five-year period ended in 2003.
Proponents of the system justify the high returns as an appropriate reward for the risk they undertake. But a recent World Bank report, "Keeping the Promise of Social Security in Latin America," minimized that, noting that through the 1990's, only three large companies accounted for half of all shares traded on the Santiago stock exchange and that pension funds tend to follow a herd instinct and invest in the safest choices on the market.
Government officials like Mr. Larraín and Mr. Scolari acknowledge that "commissions are high and need to come down." They say that "more competition is needed" to foster lower fees. But existing regulations frustrate the creation of new funds - something that seems just fine to pension funds that have become a powerful political and economic force.
"The dynamic of the market," Mr. Larraín said, "is one of consolidation and concentration."
Some other problems of the Chilean system stem from factors that do not apply with the same force in the United States and other advanced economies. Nearly half of Chilean workers, for example, are employed off the books in the so-called informal sector, while many others are hired as independent contractors, who are not required to contribute to a pension account and do not do so regularly because they cannot afford it.
By the government's own calculations, only about half the work force contributes to a pension fund. "We are aware there is a big hole and that we need to take corrective measures," Mr. Larraín said.
Because many of the claims initially made on behalf of the privatized system proved exaggerated or inaccurate, the transition period has turned out to be longer and more expensive than anticipated. The annual cost to the government, still the guarantor of last resort, has remained steady at 5 to 6 percent of the nation's economic output. (By comparison, in 2003, Social Security outlays in the United States totaled 4.2 percent of the gross domestic product.)
Chile spends about $2 billion a year to pay retirees from its armed forces, according to Mr. Scolari. The military imposed privatization on the rest of the country, but was careful to preserve its own advantages and exclude fellow soldiers from the system. Despite calls that the military be forced to give up its exemption, no civilian government has been prepared to pursue that.
Proponents of the privatized system argue that those costs will diminish in coming years, as those still receiving benefits from the old system gradually die off. But critics disagree, pointing to the large numbers of younger Chileans in the work force who either do not participate or whose contributions will fall short of the amount required for a minimum pension.
For those remaining in the government's original pay-as-you-go system, the maximum retirement benefit is now about $1,250 a month. The National Center for Alternative Development Studies, a research institute here, calculates that to get that same amount from a private pension fund, workers would have to contribute more than $250,000 over their careers, a target that has been reached by fewer than 500 of the private system's 7 million past and present contributors.
This leaves many Chileans in a situation that has led to the coining of a phrase: "pension damage." There is now even an Association of People With Pension Damage, 157,000 members and growing, that consists of Chileans, mostly former government employees, who find that their pensions, based on contributions to the private system, are significantly less than if they had remained in the old system.
"They come to us in desperation," said Yasmir Fariña, the group's president, "because those who stayed in the government system are often retiring with monthly pensions twice as large as everyone else's."
WASHINGTON — Back in 1997, proponents of overhauling Social Security met with the man who would become their most powerful convert: Texas Gov. George W. Bush, whose presidential ambitions were beginning to gel.
The governor dined with Jose Piñera, architect of Chile's 1981 shift from government pensions to worker-owned retirement accounts, in a meeting that helped bring Bush a big step closer to embracing a similar plan for Social Security in his emerging presidential platform.
"I think he wanted to support the idea but needed to be convinced," said Edward H. Crane, president of the libertarian Cato Institute, who was at the dinner. "I really think Jose convinced him."
This week, President Bush's plan to allow younger workers to divert Social Security taxes into personal investment accounts will be a centerpiece of his State of the Union address and a barnstorming tour of the country. It is a tough sell to an uncertain public, but Bush has a secret weapon: A generation of free-market conservatives like Crane and Piñera has been laying the groundwork for this debate.
"It could be many years before the conditions are such that a radical reform of Social Security is possible," wrote Stuart Butler and Peter Germanis, Heritage Foundation analysts, in a 1983 article in the Cato Journal. "But then, as Lenin well knew, to be a successful revolutionary, one must also be patient and consistently plan for real reform."
Now, Bush is drawing on a deep reservoir of resources — including policy research, ready-to-hire experts and polling on how to discuss the issue — that conservatives have created over the last 20 years.
When he needed a committed ally at the highest levels of the Social Security Administration, Bush two years ago tapped Cato's staff. When Bush told African American leaders last week that blacks would especially benefit from his proposal, he drew from a controversial 1998 Heritage Foundation paper arguing that African Americans were shortchanged by the current system because of their shorter life spans.
Thanks in part to the work of think tanks like Cato, Heritage and the National Center for Policy Analysis, Bush is also benefiting from a public opinion climate that is far more receptive to changing the government retirement system than it was 20 years ago.
That is partly because these groups have broadcast a consistent message: Social Security is financially unsustainable and will collapse after the baby boom generation retires. Although that is debatable, polls show that most Americans lack confidence in the program's future.
"It started as the third rail of politics, but over a period of time conservatives kept at it until [their assumptions] began to sound like common sense," said George Lakoff, an expert in political communication at UC Berkeley.
Critics of personal accounts, such as the AFL-CIO and the seniors lobby AARP, have mobilized to counter that Social Security is in good health and sustainable with minor modifications. They also argue that to pay for worker-owned accounts, the government would have to cut benefits or take other steps that undermine the health of the system.
Critics also point to the Chilean program that Bush cites as a model, and say it demonstrates the potential pitfalls of private accounts. Recent reports indicate that, as the first generation of Chilean workers on their new system begins to retire, many believe it is failing to deliver as much in benefits as they would have received under the old system.
But Dan Maffei, spokesman for Democrats on the House Ways and Means Committee, concedes: "Democrats are playing catch-up, because they haven't done 20 years of groundwork."
When free-market economist Milton Friedman advocated privatizing Social Security in 1950s and 1960s, it was mostly an academic argument. By 1977, when Crane established the Cato Institute to advance libertarian ideas, Social Security was a signature issue.
Even as a young man, Bush was sympathetic to revamping the program. When he ran for Congress in 1978, he argued that the program would go broke by 1988 if people were not given the ability to invest the money themselves, according to the Texas Observer. But Bush lost that House race and apparently was not persuaded to push the issue again until decades later.
Most politicians of both parties remained skittish about Social Security changes, even after President Reagan was elected in 1980 on an anti-government platform.
Edwin Feulner, president of the Heritage Foundation, remembers meeting in the Capitol with House Republicans to discuss policy after Reagan's election. After discussing such topics as transportation and foreign aid, Feulner broached Social Security, but Rep. Robert H. Michel (R-Ill.), then the House GOP leader, interrupted by placing a cautionary hand on his arm.
"We don't talk about changes to Social Security inside this building," Michel said.
Reagan quickly learned why. In 1981, he proposed cutting benefits to shore up the retirement fund, which was close to insolvency. That drew a hailstorm of criticism and contributed to heavy GOP losses in the 1982 elections.
Social Security was instead rescued in 1983 by a commission that gave scant consideration to offering a private accounts alternative. The panel recommended bailing out the program with payroll tax increases and benefit cuts, a plan approved by a bipartisan majority of Congress.
After that experience, analysts Butler and Germanis argued in their prescient 1983 article — provocatively titled "Achieving a 'Leninist' Strategy" — that privatizing Social Security required a calculated, long-term campaign to transform the political environment.
The steps they recommended were strikingly similar to the course Bush has taken: reassuring retirees that their benefits would not be cut and arguing that Social Security is financially unstable.
"Our reform strategy involves what one might crudely call guerrilla warfare against both the current Social Security system and the coalition that supports it," they wrote. "An economic education campaign … must be undertaken to demonstrate the weaknesses of the current system."
What's more, they argued, "building a constituency for Social Security reform requires mobilizing the various coalitions that stand to benefit from the change…. The business community and financial institutions, in particular, would be an obvious element in the constituency."
That foreshadowed the course conservatives took through the 1980s and 1990s.
They issued studies detailing Social Security's long-term financial problems, promoting the idea that the program would go bankrupt. They wrote that benefit checks represented a low rate of return on each worker's tax payments, an idea pioneered by the Heritage Foundation. By viewing tax payments as a poorly performing investment, they challenged the long-standing image of Social Security as a form of pooled, national insurance for the elderly.
But as of 1996, changing Social Security was not Republican orthodoxy. Steve Forbes endorsed the idea when he ran for president that year, but he was hammered for it by Sen. Bob Dole of Kansas, who became the GOP's nominee.
The political climate changed significantly over the course of the 1990s. Even some Democrats, such as Sen. Daniel Patrick Moynihan of New York and President Clinton, warned about Social Security's long-term financing problems and started toying with the idea of private accounts.
A 1999 Cato report gave Republicans a new rationale for market-oriented change. The study found that people with stock investments were more likely to sympathize with Republican policies of cutting taxes and curbing government spending. That bolstered a view, shared by some Bush advisors but rarely expressed publicly, that changing Social Security to increase the number of people with a stake in the stock market would help the Republican Party expand its base.
By 2000, every GOP presidential candidate except for Gary Bauer supported worker-controlled retirement accounts.
Bush's support was prodded by his 1997 meeting with Crane and Piñera. At the time of the meeting, arranged by Cato supporters in Texas, Bush had reservations about whether the issue was too politically explosive to campaign on, Crane said. But Bush was already clearly well-versed in the subject.
"I was pleasantly surprised by the kind of intelligent questions he asked," said Crane.
When he finally put together his presidential campaign, Bush found the idea of expanding private investment through Social Security an especially appealing part of his theme of "compassionate conservatism," according to a former Bush aide.
"There is a fundamental difference between my opponent [Democratic nominee Al Gore] and me," Bush said in May 2000. "He trusts only government to manage our retirement. I trust individual Americans. I trust Americans to make their own decisions and manage their own money." It was the kind of free-market argument that fellow conservatives had been honing for years.
During his first term, Bush appointed a commission to recommend changes in Social Security that was as heavily stacked with proponents of personal accounts as the 1983 commission was stacked against them. It produced a report that outlined three options, all of which included some form of personal accounts.
Now that he is pushing for Congress to act, Bush is tapping the community of long-standing advocates of private accounts. The White House regularly consults the think-tank experts who have been writing about Social Security for decades. The administration's point man on Social Security, Charles P. Blahous III, is former executive director of a business coalition formed to lobby for personal accounts.
The revolving door has swept a top Cato analyst into the upper echelons of Bush's apparatus for promoting the new policy: Andrew G. Biggs, who spent several years at Cato, now is associate commissioner for retirement policy at the Social Security Administration.
For these free-market devotees, winning the Social Security battle would be more than just the capstone of Bush's second-term agenda. It would also be the culmination of a generation-long drive to chip away at the New Deal's cornerstone and transform the role of the federal government.
"You have extremely high expectations among conservatives that real change is going to take place," said Stephen Moore, an activist who backs overhauling Social Security. "Conservatives have waited 20 years for this alignment."
The fight over Social Security is, above all, about what kind of society we want to have. But it's also about numbers. And the numbers the privatizers use just don't add up.
Let me inflict some of those numbers on you. Sorry, but this is important.
Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.
To explain why, I need to talk about stock returns. The yield on a stock comes from two components: cash that the company pays out in the form of dividends and stock buybacks, and capital gains. Right now, if dividends and buybacks were the whole story, the rate of return on stocks would be only 3 percent.
To get a 6.5 percent rate of return, you need capital gains: if dividends yield 3 percent, stock prices have to rise 3.5 percent per year after inflation. That doesn't sound too unreasonable if you're thinking only a few years ahead.
But privatizers need that high rate of return for 75 years or more. And the economic assumptions underlying most projections for Social Security make that impossible.
The Social Security projections that say the trust fund will be exhausted by 2042 assume that economic growth will slow as baby boomers leave the work force. The actuaries predict that economic growth, which averaged 3.4 percent per year over the last 75 years, will average only 1.9 percent over the next 75 years.
In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.
The price-earnings ratio - the value of a company's stock, divided by its profits - is widely used to assess whether a stock is overvalued or undervalued. Historically, that ratio averaged about 14. Today it's about 20. Where would it have to go to yield a 6.5 percent rate of return?
I asked Dean Baker, of the Center for Economic and Policy Research, to help me out with that calculation (there are some technical details I won't get into). Here's what we found: by 2050, the price-earnings ratio would have to rise to about 70. By 2060, it would have to be more than 100.
In other words, to believe in a privatization-friendly rate of return, you have to believe that half a century from now, the average stock will be priced like technology stocks at the height of the Internet bubble - and that stock prices will nonetheless keep on rising.
Social Security privatizers usually defend their bullishness by saying that stock investors earned high returns in the past. But stocks are much more expensive than they used to be, relative to corporate profits; that means lower dividends per dollar of share value. And economic growth is expected to be slower.
Which brings us to the privatizers' Catch-22.
They can rescue their happy vision for stock returns by claiming that the Social Security actuaries are vastly underestimating future economic growth. But in that case, we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.
Alternatively, privatizers can unhappily admit that future stock returns will be much lower than they have been claiming. But without those high returns, the arithmetic of their schemes collapses.
It really is that stark: any growth projection that would permit the stock returns the privatizers need to make their schemes work would put Social Security solidly in the black.
And I suspect that at least some privatizers know that. Mr. Baker has devised a test he calls "no economist left behind": he challenges economists to make a projection of economic growth, dividends and capital gains that will yield a 6.5 percent rate of return over 75 years. Not one economist who supports privatization has been willing to take the test.
But the offer still stands. Ladies and gentlemen, would you care to explain your position?
E-mail: krugman@nytimes.com
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