Crises and Pensions: Lessons from the Global Financial Collapse by SEBASTIAN EDWARDS University of California, Los Angeles May, 2010

The three pillars of Chile’s economic success n Openness and international competition n Strong institutions and the application of the rule of law n Pension system based on capitalization

Crises and pensions

One of the most remarkable aspects of Chile’s privately run capitalization system is that it has survived the crisis very well…

Much better, indeed, than what some international commentators and “gurus” have been arguing in speeches around the world…

Value of Chile’s five funds in relation to the pre-crisis level

Any serious analysis of the relative merits and de-merits of the privately- managed capitalization system has to compare it to the alternative: government-run regimes… Any serious analysis of the relative merits and de-merits of the privately- managed capitalization system has to compare it to the alternative: government-run regimes…

… and when this comparison is done, the result are illuminating…

Government-run, defined-benefit, pension systems are in very serious shape…

The main reason is that public sector debts have exploded…

In contrast, Chile’s debt-to- GDP ratio is only 9 percent!

… worse yet, prospects are not good, going forward… projections for the USA…

… and this is the “good news”… in reality things are much worse… n Government-run systems are not “marked to market” n The recent strength of government bond prices hide the tremendous risks involved (although the Greek crisis is beginning to change things)…. n The true debt of government run programs are “hidden costs”; contingent liabilities that are not captured by conventional accounting… n It has been calculated that the “hidden” social security and Medicare debt in the US is 59 trillion USD !

In California, the government-run pension system is in serious crisis…

It has recently been estimated that the true shortfall of the three most important government-run pension schemes exceeds half a trillion dollars…

This has affected the lives of millions of people that have seen their net salaries reduced, and their contributions to the pension system increase…... it has even happened to modest university professors…

Hasta la vista, baby!

Where is my pension?

The recent European crisis of the PIIGS shows that unfunded pension systems can exacerbate a serious crisis…

Unfunded pension obligations…

From the news: n “Reforms in Greece’s pension system envisage 30% cut in the pensions and increase of the retirement age with up to 15 years, Greek Ta Nea daily reports”. n “Greece on Sunday announced more austerity measures … through 2012, to be achieved through … pension pay cuts…”

Bond yields: Greece, Portugal and selected Latin American countries

Other important contributions of the privately-administered, capitalization systems…

Contributions to long-term economic growth…

Capital accumulation, requires savings

Productivity growth requires innovation and dynamic capital markets…

A well-designed privately-managed system – that is, one with a “solidarity pillar” – also helps reduce poverty and inequality…

Challenges and pending reforms for capitalization systems

A modest list of possible improvements n Encourage voluntary savings for old age n Design properly company-sponsored and company-funded programs n Increase coverage n Implement mechanisms that deal with people’s behavioral inertia n Involve independent and informal workers in the system

n Eliminate gender discrimination n Increase the offer of investment funds n Add flexibility to portfolios (make investment limits flexible) n Regulate the exposure of savings to risk during years prior to pension decision n Implement a safety net that, without discouraging contributions, provides a minimum pension to poorer people (joint with negative income tax)

n Reduce management costs n Improve risk management n Design rules that reduce exposure to sudden dips in market in period immediately preceding retirement

Summary n The merits of a system is proved in difficult times, in times of crises n The privately-managed, capitalization based pension regimes have shown to be robust n To be sure, in many countries they could improve with reforms aimed at greater efficiency and better risk management n However, when compared with government-run regimes the result are, by and large stellar n Contrary to what some gurus have said, we need more capitalization regimes, not fewer