NS4540 Winter Term 2019 Latin America’s Pension Trap Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

Overview I Robert Looney, Latin America’s Pension Trap, Milken Institute Review Not long ago speculation that booming growth in Latin American countries such as Brazil and Chile would result in convergence with advanced countries Not so today. Instead Brazil, Chile, Argentina Uruguay and Costa Rica Find themselves caught in a pension trap as changing age demographics combine with slowing growth to make their national retirement systems increasingly unsustainable

Pay-as-you-go Systems I The effects of the pension trap most pronounced in countries with pay-as-you-go pension systems (PAYG) these include Brazil Argentina Uruguay and Costa Rica PAGY systems work well for a time until the Population ages Economy slows and Pension benefits begin to exceed revenues

Pay-as-you-go Systems II Once the pension trap kicks in the only long-term fix is through unpopular reforms such as Raising current workers’ contribution rates Cutting pension benefits and Raising retirement age Without such reforms maintaining retirement benefits takes an increasing economic toll and creates a vicious circle wherein the Diversion of scarce revenues to pensions from investment, education and other growth-enhancing sectors Leads to a further reduction in growth and Thus the government’s ability to meet its pension obligations

Brazil I Case of Brazil Brazil’s birth rate is Falling faster than previously estimated while Life expectancy continues to rise Implications – over next few decades: The number of working age (15-59 years) Brazilians will grow by about 0.5% annually Those over 65 will grow at 3.0% With most over 65 eligible for pensions the number of demands on the retirement system expected to rise to 20 million in 2020 65 million by 2050 and 75 million by 2060

Brazil II Further complicating an already bad situation are Brazil’s Slowing economy and Declining productivity trends. Brazil’s labor productivity decreased from an annual rate of 1.2% per annum in the 2000s to -0.7% in 2010-16 For the same period total factor productivity (TFP) fell from 0.9% to -1.6% Average growth in investment fell from 5.3% to -2.5% Result were a decline in potential growth rate from 3.6% in the 2000s to 0.5% in 2010-16 and Actual growth rate fell from 3.8% to 0.3%

Brazil III Despite fiscal slowdown and pension shortfall, government responded by just expanding tax revenues Taxes jumped from average of 35.4% GDP in the 2000s to 37.2% from 2020-16 Outlays expanded from 32.5% to 35.4% during the same period Raising taxes at best a short-term fix given the pension system already dispersing funds equal to around 12% of GDP An annual shortfall of 4.8% exists equivalent to more than half the government’s budget deficit

Brazil IV Long term solution will require changing the system’s fundamental rules Currently most Brazilian workers who contribute to the pension system can retire after 35 years Those in categories considered dangerous or strenuous can retire on a full pension after 24 years. In a country where many people enter the job market at 18 or even 15 and a life expectancy is 75 and increasing, Retirees can begin drawing pensions in their 40s or 50s Unless action taken soon, Brazil’s fiscal deficit is predicted to become unmanageable within a few years.

Brazil V Unfortunately, strong pension reforms are not in the cards Reforms deeply unpopular – seen as infringing on worker rights In Late 2017 the Temer administration began watering down the pension reform bill and in the process negated an estimated 60% of its potential savings

Brazil VI Genuine and far-reaching pension reforms critical to Brazil’s economic well being Alone now sufficient to turn economy around Given trends in productivity and investment, return to high growth rates of the 2000s is out of reach in the short term For the longer term, Brazil’s economic fortunes will depend on the government’s ability to channel revenues and enact reforms as to Reverse the country’s declining productivity trends Strengthen market forces, and Increase the flexibility of the country’s domestic resources.

Chile I Similar scenarios playing out in Latin America’s other PAYG countries, especially Argentina which like Brazil faces a severe funding gap. However the pension trap isn’t confined exclusively to PAGY countries As Chile demonstrates may also occur – with less catastrophic consequences – when private, defined contribution national systems fail to meet their payout promises.

Chile II Chile privatized its PAGY state pension system in 1981 as part of the Chicago school experiment in free market economics Under the new system, workers contribute 10% of their annual income to a retirement account managed by a financial services company. In exchange for these regular contributions workers originally promised they would receive a pension equal approximately 70% of their final working income. Unfortunately when defining the level of worker contribution, the system’s architects did not factor in the growth of wages and purchasing power that would accompany development

Chile III As a result – 40 years later the system is facing and failing the acid test of finally paying out pensions. Instead of the promised 70% of final working income, current pension rates equal only around a pre-tax 33% of the wage for an average male earner and 29% for women – in many cases these are below the poverty level Facing intense public pressure to make up the shortfall, Chilean government considering using fiscal revenues to boost pension Also debating whether to allow workers to shit to PAGY system – short run solution with long run consequences given Chile’s aging popultion

Chile IV With a retirement age of 60 for women and 65 for men combined with a life expectancy of 78 Either option would come at a substantial cost to a country already facing a marked slowdown in growth and recent downgrade of its credit rating.

Assessment Unfortunately no magic pension bullets for Latin America Pension systems and reforms regardless of their form in rapidly aging countries such as Chile, Argentina and Brazil likely to fail if healthy increases in productivity and growth not restored. Without increases in resources needed to meet pension obligations, these countries are facing a very bleak future On the other hand those countries such as Guatemala, Bolivia, Paraguay and a score of others still experiencing strong rates of population growth Would be will advised to learn from the mistakes of those whose demographic transitions proceeded them.