For twenty-five years or so, the privatised pension scheme introduced in Chile under the Pinochet regime by his labour minister, Jose Pinera, has been touted as a model for the world to follow. It’s been particularly influential in the US debate over social security privatisation but has also had some influence in Australia, which has a somewhat similar setup, though we arrived at it by a different route – Chile scrapped its defined-benefit state pension scheme, keeping a basic safety net, Australia started with a means-tested flat-rate pension, but has tried to expand private superannuation since the 1980s
Now the New York Times reports that the Chilean scheme is not delivering the promised benefits . Lots of people are getting less than they would have under the old scheme and large numbers are falling back on the government safety net. Fees have chewed up as much as a third of contributions.
Why has this bad news taken so long to emerge. Complaints about fees have been around almost since the start, but right through the 1980s, they were ignored becuase investment returns were exceptionally high. This in turn reflects the fact that Pinera had the good luck or good judgement to start the scheme when the stock market was at an all-time low, thanks to a financial crisis (in retrospect the first of many cases where financial market darlings got into trouble). The economy recovered and the stock market boomed. Once gross returns fell back to normal levels, the bite taken out by fees became unbearable.
All of this raises the issue of risk. Under a privatised defined-contribution, your returns, and therefore your retirement, depend heavily on timing. 1981 was a great time to start investing in the Chilean stock market, and also in the US market. At least for the US, 2000 was a good time to get out. Anyone who started investing in the US market in the late 1990s (and didn’t manage to outperform it) is well behind where they would have been if they had put their money into government bonds.
On average, returns from the stockmarket are higher. But this is just another way of saying that, on average, investors want a higher return to justify the additional risk. So a switch from a defined-benefit scheme to a private accounts scheme with the same average return and higher risk is a real loss, just as if someone sought to repay a debt contracted in 1981 with the same amount in 2005 dollars.
I’ll have more to say about this soon, I hope.