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South America Offers a Lesson In Privatizing Pension Systems


By: Pamela Druckerman
Wall Street Journal, July 30, 2002


In 1984, just a few years after Chile privatized its lumbering state-pension system, Cristian Jara eagerly opened an account and began making monthly contributions. Now 41-years old and head of sales at a medical supplies company, Mr. Jara is convinced his account's sometimes rocky growth, alongside that of Chile's economy, will provide a comfortable nest egg when he retires.

Across the Andes in Argentina, Perla Crivolitti, an executive secretary who is also 41, is convinced she will never see any of the money she has been socking away in a private retirement account since Argentina began allowing the funds in 1994. Her last financial statement showed her account was valued at about $2,200, down from $15,000 before Argentina spun into government debt default and currency devaluation in December.

"My savings of many years have been converted into nothing," she says angrily.

South American countries that have taken the private-pension plunge offer both encouraging and cautionary tales for the U.S., where the Bush administration's plans to partly privatize the Social Security system have been postponed, but not canceled, by the stock market's deep decline and by Democrats' opposition. In Argentina, many retirement accounts have been devastated, and the pension system has grown increasingly frail amid the broader economic meltdown. In Chile, however, turbulence in financial markets has ruffled pensions but hasn't caused deep damage.

While significant Social Security reform in the U.S. isn't likely to get serious consideration until after the 2004 presidential elections, demographics eventually will force change, and Mr. Bush's top economic advisers maintain that individually managed accounts will be part of the solution.

The Bush team is seeking far less radical change than that undertaken by Chile and Argentina, where private plans are the sole source of income for most retirees, rather than a supplement to the public system. In recent remarks, a spokesman said Mr. Bush wants to allow younger workers to divert just a portion of their earnings to private pension plans instead of to Social Security.

Still, experts say the U.S. government would face dilemmas similar to those encountered farther south: how to cushion against big declines in financial markets and how to keep paying retirees who are owed state pensions, even after the government loses revenue from younger workers who switched to private plans.

Both Chile and Argentina sought to protect workers, most of whom had never owned stocks or bonds, by initially limiting the funds to government bonds and then gradually permitting workers to buy corporate debt and a limited amount of stock. This proved effective in Chile: Though returns still varied sharply from year to year, from gains of almost 30% in 1991 to just 3% in 1992, the funds posted average annual returns of 10.5% through June. One of the main classes of Chilean pension funds, which has a blend of stocks and bonds, rose 2.6% through June, even though stocks were mostly flat and economic growth has been weak.

And Chile paid for the transition to a private system primarily by raising taxes and trimming some government spending. "The end result was that the Chilean public sector had a surplus from the late 1980s through 1999," says Juan Andres Fontaine, an economic consultant in Santiago.

"The Chilean transition was harsher but also more prudent," says Andres Velasco, professor of international finance at Harvard University and an independent economist with LatinSource Inc.

Argentina, where the cost of continuing payments to retirees amounted to as much as 2.5% of gross domestic product each year, plugged this gap by borrowing heavily in the mid- to late 1990s. The growing debt load, including bonds issued to keep the state-retirement system afloat, became difficult to service as the economy plunged into a recession. In December it declared a moratorium on payments, devastating local pension funds, which had adopted the seemingly conservative strategy of putting about three-quarters of their funds into government debt. Although returns averaged 12.38% annually through July, the value of an average portfolio fell 56% in dollar terms between January and June.

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