Success of Chilean Pension System: Myths vs. Reality

"Volcan Osorno & Chilean flag" by Markoparkhill | Licensed under CC BY-SA 3.0 via Wikimedia Commons

The debate on the potential reform of the Polish pension system has brought to light many fallacies about capital pillar of the system. Interestingly enough, the Chilean example was commonly used to support those arguments. Nevertheless, it seems that (more often than not) the understanding of the Chilean pension system was based on pure misconceptions. Let’s clear some of them up.

The most common myths about Chilean pension system, which were not proven by facts, include:

  1. Pay-as-you-go pension system worked fine (until 1981) and the reasons for pension reform were ideological (policy of the so-called Chicago Boys).

  2. Capital pension system leads to an inescapable increase of public debt. It did not happen in Chile because of significant income from copper export used to finance public deficits generated by the pension reform. The mineral wealth of Chile makes this example an exception and it is not eligible for international comparisons.

  3. The crisis of 2008 discredited the sense of capital pension system because the AFP (Chilean counterpart of Polish OFE) lost major part of earnings generated during last quarter of the century.

  4. Failure of the Chilean system is evident because of low pensions distributed by the AFP and the fact that “three out of four pensioners receive their pension or a part of it from the state” (after prof. M. Riesco).

  5. Companies managing the pension funds collect very high fees for their activities. As a result Chilean pension system based on private pension funds is “a benefit for a narrow group, which is gambling our money” (after E. Lagos).

  6. For an economy it is not important whether pension system is based on private pension funds or state pay-as-you-go model.

In contrast to these myths, our findings based on the analysis of nearly 35 years’ of experience of the Chilean pension system show that:

  1. Capital pension system is a very efficient mechanism of accumulating savings for future pensions.

  2. The continuity of contribution payments and entry to the system from the youngest possible age are essential.

  3. The enhancement of competition between companies managing pension fund is necessary in order to reduce the costs of the system.

  4. Capital pension system contributes to GDP growth, which means higher pension level in the future.

After 35 years of the reformed Chilean pension system, we see that it was successful in multiplying the pension capital of its participants. Is also had a positive impact on the Chilean economy and public finance. Chilean AFP were capable of generating higher rates of return than those, which could be offered by the state-run pension system. After changes conducted in 2008, fees collected by the Chilean pension funds are one of the lowest in the world. Conservative budgetary policy led not only to systematic surpluses in the public budget but neutralized the costs of pension reform. Today Chile is one of the least indebted countries in the world with low official and implicit debt and well-functioning pension system. Such a case is extremely rare among the most developed countries struggling with ageing societies and rapidly growing public debt. Popular myth that the Chilean pension system has not performed well because many Chileans receive low pensions ignores some important economic facts: relatively long breaks in pension contributions, income inequality and very low rate of contributions. Nevertheless, these are the factors non-dependent on pension system and as a result do not account for the failure of this system.

Conclusions that may serve as recommendations for Poland are therefore obvious. Capital pension system fulfils its role when it comes to accumulation of real savings which enhance GDP growth. Moreover, capital pension system is more efficient than pay-as-you-go pension system in minimizing negative impact of demographic changes on public finance deficit and public debt.

Full analysis in Polish available here.

Translated by: Aleksander Kwiatkowski

Pawel Wieprzowski