Once touted by its creator as the “Mercedes Benz” of pensions, Chile’s defined contribution scheme is suffering major outflows.
For over 40 years Chile, South America’s most privatised economy, where even the water is in private hands, has been held up as a poster child for neoliberal economics. The Pinochet dictatorship’s early years certainly provided the perfect testing ground for free market reforms conceived in the classrooms of the University of Chicago. The Chicago Boys, a group of 30 Latin American economists who had become acolytes of Milton Friedman as students in the US, took up key policy roles in Pinochet’s government. In next to no time they had unleashed a battery of reforms that made their mentor proud — at least for a short while.
But in the end, as Yves documents in ECONNED (cited here), Chile was not really a successful “free markets” experiment. Key parts of the economy, such as the copper mining industry, remained under firm government control. The Chicago Boys’ policies gave birth to a massive debt-fuelled speculative bubble, with “the funds going mainly to real estate, business acquisitions, and consumer spending rather than productive investment.” The rich made out like bandits, as state assets were sold for huge discounts to connected insiders, while the poor got even poorer. For many of them, as Yves put it, “the Catholic Church’s soup kitchens became a vital stopgap.”
And then the boom turned to bust, leaving Pinochet’s government little choice but to reverse many of the Chicago Boys’ policies:
The bust came in late 1981. Banks, on the verge of collapse thanks to dodgy loans, cut lending. GDP contracted sharply in 1982 and 1983. Manufacturing output fell by 28% and unemployment rose to 20%. The neoliberal regime suddenly resorted to Keynesian backpedaling to quell violent protests. The state seized a majority of the banks and implemented tougher banking laws. Pinochet restored the minimum wage, the rights of unions to bargain, and launched a program to create 500,000 jobs.
One of the Chicago Boys’ most enduring legacies — Chile’s fully privatised pensions system — is now beginning to unravel. Created in 1980, it was the first pensions system in Latin America that depended entirely on compulsory workers’ contributions. The model has since served as a template for similar systems in emerging economies across the world. But its days appear to be numbered, which is causing all sorts of consternation, not only among Chile’s large business owners, managerial class and the administrators of the pension funds (AFPs) but also at banks and funds on Wall Street.
The System’s Losers
Here’s how the system works: all employees within the formal economy must pay at least 10% of their monthly salary to for-profit funds, called AFPs. The government plays no role — or at least is not supposed to — and employers do no have to contribute anything. Employees must also pay the eye-watering commissions charged by the AFPs for managing their money, most of which is invested in large Chilean banks, large Chilean companies and overseas assets. In return, most pensioners — particularly those at the lower end of the income scale — receive a measly pension at the end of their working lives.
Many people in the country, particularly those in the informal economy, cannot make regular enough contributions to end up with sufficient payouts. But the system itself is designed not to pay pensions, says Chilean economist Manuel Riesco. According to a study he conducted in 2013, workers in 2012 paid out more than twice (4.3 trillion pesos) the amount of money they would end up receiving (2.1 trillion pesos). What’s more, the State provided 1.4 trillion pesos in subsidies to the AFPs — equivalent to two thirds of the amount paid out in pensions. In other words, just over one out of every three pesos invested actually got paid back.
The result is widespread penury. In 2020, over half of Chile’s retirees received under $203 a month or less last year — in a country where prices for basic products and services are comparable to those in many European countries.
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