As I stated in two previous columns, "NO+ PAYGO: why is the pay-as-you-go system unviable today" and "Yes+ AFP (Private Pension Fund Managers): why the individual capitalization system is the right path", the year '80 Chile made the right decision to replace the pension system based on a pay-as-you-go mechanism for an individual capitalization mechanism administered by specialized private companies.
The current government has announced changes to the current pension system, where it proposes to raise the individual contribution by an additional 5% and that to be administered by a new autonomous state entity. From the additional 5%, 2 percentage point would go to a collective savings insurance and the other 3 percentage points to the individual workers' accounts.
Creating a new state entity to manage the additional contribution increases the system's operating costs and decreases the expected returns on the fund to which the contributors can aspire.
The state has shown not to have competencies to efficiently manage the resources and less to obtain a greater profitability of them. For example, in the last three years the average annual real return obtained by the funds managed by the AFPs is 4.93% on a simple average of funds A to E (A 5.95%, B 5.47%, C 5.15%, D 4.35%, E 3.75%), which compares favorably with the estimated real profitability of 0.16% per annum achieved by the Economic and Social Stabilization Fund (FEES), or the estimated real profitability of 1.44% of the Pension Reserve Fund (FRP), which started in 2007. Even more, during the last three years, the small contributions that the authority has made to the FRP have been financed with withdrawals from the FEES. Beyond the conservative investment strategies of the FEES and the FRP, their expected return is significantly lower than the ones achieved by the more conservative funds administered by the AFPs, Fund D or E.
The value of workers' funds administered by the AFPs in March reached CL $ 123,414,480 million, increasing by CL $ 13,159,135 million in one year, due to the contributions and profitability obtained. For its part, the FEES, which started in 2007, since its creation has received contributions of US $ 21,765.71 million, and has suffered withdrawals of US $ 10,852.81 million. And, today, its value reaches US $ 14.048 million. Of the total withdrawals that have been made from FEES, US $ 9,277.71 million were withdrawn in 2009, the year of presidential elections. In the case of the Pension Reserve Fund, it now accumulates US $ 9 billion, and by law as of this year, it allows the Treasury to withdraw about US $ 600 million to finance the Solidary Pension Pillar (basic solidarity pension -PBS- and social security contributions -APS-). And, where, until the year 2016, the resources to finance the payment of these benefits were contemplated in the fiscal budget. It remains to be seen how the Ministry of Finance will manage this additional source of funding to mobilize additional resources in a year of presidential elections.
The quote of an additional 2% that would go to collective savings insurance is a new labor tax, a regressive tax. And if it materializes, it will affect the workers, the middle class, and all those who depend on a living wage. The announcement made by the authority, emphasizes the 5% increase in workers contribution. But, says nothing about increasing the state's contributions to the Solidarity Pillar, and on to the chances to finance that contribution by reducing public spending, or on making a more efficient use of government revenues.
The additional contribution of 5% must go entirely to the individual capitalization accounts of the workers, these resources must be heritable, and individually are the workers who must decide which pension fund administrator must manage their resources. The creation of a new autonomous state entity would only increase the costs of the system, and will not generate higher returns than those managed by Pension Fund Administrators, specialized in portfolio management.
Achieving higher levels of efficiency, competition, and delivering greater pensions to workers are not resolved with the creation of a new autonomous state entity. If not rather, these objectives are achieved by increasing the competitive spaces between the AFPs, and leading the economy to a path of sustained economic growth, generating more and better jobs in the formal sector; and not with policies that slow growth and lead to greater informality and precariousness of the labor market, which will eventually have an impact on a greater demand for social assistance over the state.
The history of Chile has shown that it is easy and tempting for those who are leading the state apparatus to use the contributed resources from citizens and taxpayers, and history has also shown that on uncountable occasions they have not been good at administering those resources on the benefit of the governed.
I leave a question to comment: does the proposal of the authority imply a tax increase?