One size does not fit all. Such is the corollary of 20 years of experimentation with pensions all over the world. Did the world need two decades to reach it? Unfortunately, yes. Twenty years ago, in 1994, the World Bank published its Averting Old Age Crisis, a detailed study with basically one recommendation: everybody should follow the Chilean pension model, that is, a totally privatized system.
Averting Old Age Crisis signaled the climax of the so-called Washington Consensus: the idea that Latin America should follow a ‘laundry list’ of basic precepts to achieve economic growth. It was presented in the World Bank and IMF Annual Meetings that took place in September 1994 in the capital city of a country that at the time was a poster child of the effects of liberalization and opening and economy: Madrid.
Nowadays, however, nobody wants to follow the Chilean system. In 2005, the World Bank announced that the recommendations of Averting Old Age Crisis were not longer valid. Of the 11 countries that have adopted the Chilean model, only Chile keeps it untouched. And that will probably not last too long: next month Chile will start a review that could end up triggering the creation of a government-owned pension fund that would compete with private financial institutions.
So, this is a good time to analyze what is happening with pension systems in Latin America. This is the aim of a course to be held in Miami from July 14 to July 18, organized by the London School of Economics, Santander Asset Management and Novaster.
The ‘all privatized’ pension systems have failed precisely in the areas where they were supposed to win. At a management level, pension costs have not fallen in spite of the fact that, at least in theory, competing management funds should be more efficient than government bureaucracy. From a macroeconomic perspective, private pension plans have not always meant a better allocation of capital, perhaps because in many developing countries there are not too many markets to invest in. That lack of investment opportunities creates another problem: often, the returns of the private pension funds are low, or even negative. So, instead of helping to fight the demographic time bomb that public pensions face, they worsen it.
Another risk is Government interference. Argentina's Government forced the pension funds, created in 1994, to buy assets denominated in pesos to prop up the country’s beleaguered debt. That was a catastrophe for savers in 2001, when Argentina defaulted on its debt and saw the peso collapse, and paved the way for the late President Néstor Kirchner’s renationalization of the system seven years later. In small countries, such as Bolivia and El Salvador, the private system ended up creating a duopoly, simply because there are not enough savers to keep six or seven fund managers. The problem is not just a Latin American one: pension reform in Hungary, in 1997, ended up in disaster.
Why did it work in Chile and failed in so many other places? Carmelo Mesa, Distinguished Professor Emeritus at the University of Pittsburgh and one of the speakers at the LSE event, points out at two elements that made Chile different: “First, its informal economy is relatively small. In other countries there are a large number of workers who are self-employed in the informal sector and do not contribute to their pension plans. Chile does not have to deal with that. Second, Chile has a functioning stock market since 1898, that has provided investment opportunities to the pension funds”.
However, even the Chilean system faces hurdles, among them the stubbornly high management costs. This defies traditional economics, but, put in the light of behavioral economics is not that surprising. “Empirical experience shows that citizens have usually more urgent matters to think about than to analyze the different options offered by financial institutions”, explains Professor Nicholas Barr, from the London School of Economics, who remembers how, in the early Nineties, while at the World Bank, he tried unsuccessfully to avoid making Chile the example for everybody.
The fact that people cannot manage their accounts properly to lower their costs can sound counter-intuitive, and even patronizing, but it is a fact: if hedge funds are regularly accused of abusing their investors—who are supposedly the most sophisticated and wealthiest—, why should average citizenry with little or no financial background know how to manage their pensions?
Twenty years after the universal acclamation of the Chilean pension model by the World Bank, it has become clear that it is not the magical cure that its advocates pretended. Pensions need reform—including extending the retirement age, and combining private and public plans—but the one size fits all formula was never sound.