Fix Social Security, Ease the Credit Crisis

Fix Social Security, Ease the Credit Crisis

Op-ed in RealClearMarkets
April 29, 2009
Originally published in RealClearMarkets

Remember the looming Social Security crisis? If you don’t, you’re
not alone. The credit crisis and economic downturn have monopolized
public attention to such an extent that the Social Security crisis that
was at the center of the policy debate during President George W.
Bush’s second term now seems forgotten.

This is unfortunate,
for not only has Social Security not been fixed, but reform, if done
right by tapping into the power of the market, can help provide new
capital, which American businesses now desperately need.

To
see how this could be done, it’s worth looking at the experience of
Chile. Government officials in many other countries have looked at
Chile’s reform during the 1980s as a model. The United States should
take a look, too.

Nothing threatens a public pension system
as much as a diminishing ratio of workers to retirees. In Chile, by the
time reform began, this problem was severe. As Hernán Büchi, an
economic adviser to the Chilean government at the time, notes, in 1979
there were only two-and-a-half workers to support each pensioner. “This
ratio, combined with other deficiencies in the system, inevitably meant
that the vast majority of workers were retiring on very low pensions,”
he writes in his memoir, La transformación económica de Chile (The
Economic Transformation of Chile). Clearly, the old system needed to be
replaced with one that was sustainable.

The Chilean pension
reform required three preparatory steps. The first involved, in Büchi’s
words, “introducing some rationality into the system,” which meant
doing away with major administrative inefficiencies that had plagued
the system.

The second phase of reform involved “gradually
reducing the tax on work that was implicit in pension contributions.”
This “tax” arose out of the fact that public pension benefits bore no
relation to payments made into the system, since they were largely paid
via general revenues. Benefits were an unsupportable liability that
threatened the finances of the entire government. Another goal of this
phase was to bring these financing mechanisms under control. To do so,
Büchi notes, “the tax collection systems had to be improved and
government spending cut.”

The third, and most crucial, phase
constituted “a top-to-bottom structural overhaul of the pension
system.” The first step in this phase was to separate different kinds
of benefits ”old age, disability, workman’s compensation, and
others” to be administered separately according to the needs of each
kind of benefit.

Having reformed the framework of the
pension program, Chile then moved to tap into the power and dynamism of
the market. “The new pension system, with freedom as its guiding
principle, is founded on the individual responsibility of each worker,
reflected in his own savings capacity and his own individual account,
and in the private administration of the funds by properly regulated
companies,” writes Büchi.

Individual ownership of retirement
benefits has helped families accumulate wealth over generations. Now
parents, even of limited means, can bequeath more assets to offspring
than they ever before.

Contrary to critics, the Chilean
pension system does not leave low income individuals or those unlucky
enough to have made poor investments adrift. The system, Büchi notes,
retains a state-supported “social safety net,” that guarantees “a
minimum pension at least” to workers who have not accumulated
sufficient savings and who meet certain contribution requirements.

The
lessons from Chile’s reforms are relevant to Americans, now that
President Obama seems willing to tackle Social Security reform.

Moreover,
the Chilean reform has special value given the current need to unleash
capital. Büchi points out that Chile’s reform “helped create a
substantial private capital market.” Money previously cycled through
government agencies became available for private investment, providing
entrepreneurs with needed capital and pensioners with better returns.

As
the Obama administration and Congress struggle to address America’s
credit crisis, they should take the Chilean experience into
consideration. As the billions thrown at the nation’s economic troubles
have turned into trillions, the last thing we should do is to go
further into debt. Instead, we should unleash the wealth and savings
creating capacities of the world’s most formidable economic engine: the
American workforce