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

2. 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

3. 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

4. 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

5. 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

6. 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
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 and
Actual growth rate fell from 3.8% to 0.3%

7. 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
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

8. 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.

9. 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

10. 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.

11. 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.

12. 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

13. 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

14. 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.

15. 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.