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From Nations That Have Tried
Similar Pensions , Some Lessons
By Bob Davis and Matt Moffett, Wall Street Journal
February 3, 2005
As President Bush gears up to sell his plan to remake Social Security, he and his allies cite Chile as an example of how private accounts can boost retiree payouts.
Opponents counter with their own favorite: Britain, where a scandal engulfed an overhaul and tarnished the system.
Argentina and Bolivia show how heavy the cost of financing the transition to a save-for-yourself approach from a state-run system can be. Sweden and Poland illustrate the advantages of limiting workers' investment options. Singapore shows how workers' eagerness to tap their accounts before retirement -- to buy houses, for instance -- can leave them vulnerable when they reach retirement. And Britain shows how hard it is to regain taxpayer support for private accounts if the government bungles the overhaul.
Sweden and Poland
A conservative coalition that gained power in Sweden in 1991 began to revamp a system so generous officials feared they'd have to lift the payroll-tax rate to 36% to pay benefits by 2025. A Social Democratic government later signed on to an overhaul.
Deciding to offer private accounts, Sweden had to determine how much choice to give people to design them, an issue the U.S. would also face. Sweden chose to maximize choice. But over time, Swedish workers essentially decided they didn't want so much freedom.
Sweden's overall system is funded by payroll taxes of 18.5%, paid, as in the U.S., half by workers and half by employers. (The U.S. payroll tax totals 12.4%) Most of Sweden's payroll tax continues to pay for a traditional retirement pension. But since 2000, Sweden has used 2.5 percentage points of the total to fund "premium accounts," which taxpayers themselves manage. From about 660 mutual funds registered to do business in Sweden, they can choose a maximum of five.
![[Retirement Abroad]](tried.4.gif)
Mutual-fund firms spent $94.4 million in advertising before the system went into effect, estimates Swedish economist Henrik Cronqvist. That's a massive sum for a country with 4.4 million eligible workers.
One fund promoted investment solely in western Sweden. Another was endorsed by retired tennis star Stefan Edberg. A third called itself "Absolut Strategies," and then changed its name after Absolut Vodka objected.
In the end, two-thirds of Swedes put together their own premium pensions from the funds. The rest chose a "default" portfolio in which index funds made up 60% of the funds.
Over the next three years, as the stock market slid, many Swedes tired of picking from so many funds. In addition, the default portfolio, with much lower expenses, was doing about as well. In 2003, only 8.4% of young Swedish workers making their initial decision to manage their own premium pensions put together their own fund portfolios. The government wanted "people to take control of their retirement, but people don't seem to be interested," says Annika Sunden, a Swedish pension expert at Boston College's center for retirement research.
Poland also wrestled with questions of choice when it started an individual-account system in 1999, as a way to reduce the government's retirement payouts. Poles had 21 pension-fund managers to choose from. The government approved 450,000 sales agents -- 1% of the population -- to advise workers, many of whom had little experience in market investing.
What the agents lacked in financial expertise they made up in enthusiasm, because they were paid for each account they set up. About 18% were bogus "dead accounts," says Agnieszka Chlon-Dominczak, a Polish deputy minister for social insurance, with many holders of the accounts deceased. She says the problem is being cleared up.
From Poland and Sweden the lesson is the same: When designing a system of individual accounts, keep it simple.
Argentina and Bolivia
When Argentina set up private accounts a decade ago, one issue it faced was how to keep the transition from blowing a hole in an already strained budget.
Workers got the option of going into the new private accounts or staying in a revamped traditional system. Most chose private accounts. As some payroll taxes started flowing into private accounts rather than state coffers, the government had less money to pay existing retirees.
The same challenge would face the U.S. under President Bush's plan. He has said retirees and workers over 55 should continue to get their full Social Security payments, but a portion of payroll taxes should be redirected to individual accounts held by younger workers.
Argentina's transition was initially projected to cost a little less than 1% of gross domestic product annually, or around $2.5 billion. When the law was drafted in the early 1990s, Argentina's economy was booming, tax revenue was high and officials were confident they wouldn't have to borrow much.
But budget deficits grew because of revenue losses and added costs during an economic crisis in the mid-1990s. Caving in to political pressure, the government cut the payroll taxes paid by employers. It also bailed out failed pension systems of the provinces, which have considerable economic autonomy. By 2001, the cost of the entire social-security overhaul had grown to about 2.7% of output, according to a paper in a quarterly journal of analysis called the International Social Security Review. That amount approached the entire government budget deficit that year.
Financing the shortfall forced Argentina to borrow billions of dollars more at high interest rates, adding to an already towering debt. The shift to private accounts "didn't create the fiscal problem, but it amplified it," says Michael Gavin, an economist at UBS Warburg.
Argentine government economists argued that borrowing was justified because the pension makeover was simply turning a promise to retirees that the government would eventually have to honor into an explicit government debt. Conservatives backing private accounts in the U.S. make the same argument.
Argentina hoped investors wouldn't demand higher interest rates because the country was acting to make the system more transparent. Instead, investors eventually became so worried about the country's solvency they wouldn't lend it more money. The result was an economic collapse in December 2001. Since then, Argentina hasn't paid interest or principal on its debt, and is pressuring lenders to accept a restructuring proposal offering 30 cents on the dollar.
Transition costs also helped to batter Bolivia, which adopted private accounts eight years ago in place of a traditional pension system. Bolivia's budget deficits more than doubled because of higher-than-expected transition costs. Even with additional borrowing, the government hasn't been able to pay promised benefits to many retirees. Some have joined in recurrent anti-government street protests.
The U.S. isn't an Argentina or Bolivia. But they offer a warning. U.S. annual budget deficits as a percentage of gross domestic production are somewhat higher than Argentina's at the time of its collapse. U.S. deficits may head even higher if Washington borrows the $200 billion a year or so, for 10 years, needed to pay for a transition to private accounts alongside regular ones for some workers. While there's no danger of a U.S. debt default, foreign and other investors might demand higher interest rates to lend to an increasingly indebted U.S.
The lesson is that social security reform meant to fix an economic problem, the cost of baby boomers' retirement, can produce other problems. For Carmelo Mesa-Lago, a professor emeritus at the University of Pittsburgh, what the Argentine and Bolivian cases teach is, "You have to get the budget in order before you move toward private accounts."
Singapore
When 43-year-old Chris Firth, head of a wealth-management firm in Singapore, wanted to buy a house seven years ago, he withdrew part of the purchase price from his social-security account.
Singapore's system, called the Central Provident Fund, allows active workers to take out money from their individual accounts or in some cases to use future payments into that system for housing, medical expenses and education. Far broader than a traditional social security scheme, the fund is the government's "primary socio-economic, political planning and engineering tool," writes Mukul G. Asher, a Singapore economist.
Individual accounts began in 1955, when Singapore was a British colony. As years passed and Singapore gained independence, its government created new investment vehicles permitting early withdrawals. Each worker has a defined share of his or her contribution directed toward three accounts: the Ordinary account, used for housing, education and other approved investments; the Medisave account, for hospital costs; and an account for old age and contingencies.
The accounts have helped boost Singapore's home ownership to around 90%. But it's very costly. Payroll taxes are 33% -- 2.5 times the level in the U.S. Also, all the early withdrawals from housing and medical accounts often leave the elderly without enough money in their retirement account. Many Singaporeans today are "asset-rich but cash-poor" at retirement, a recent government panel said.
Besides withdrawals any time for housing, medicine and education, the government lets people withdraw a portion of their old-age money at 55 if they've reached a minimum savings level. Only about 40% of Singaporeans have reached that savings threshold just a few years before retirement, because they haven't saved enough or have already withdrawn so much.
Housing could be another asset to tap, if prices rose enough. But amid a series of jolts to the economy -- from the 1997-98 Asian financial crisis to the 2003 SARS virus -- housing prices in Singapore are lower than in the mid-1990s. There's been an increase in the number of Singaporeans over 65 who must continue to work.
Mr. Bush wants private accounts devoted exclusively to retirement. But as those accounts built up, so might political pressure to let people borrow or withdraw money from them.
The lesson: Allowing Social Security contributors to tap into accounts could advance worthwhile goals but at a cost of leaving retirement very unsettled.
Britain
A British social-security overhaul in the late 1980s promised fiscal probity and consumer choice. But it has been dogged by scandal, and many Britons now seek the security of state payouts. "A lot of people look longingly at [America's] Social Security system," says Stephen Yeo, a partner in London at pension consultants Watson Wyatt Worldwide.
All British retirees get modest payouts from a basic state pension. They are much less generous than in the U.S. Employer-based pensions in the United Kingdom generally have bigger payouts, and there's also a supplementary state plan.
In 1988, worried that baby-boomer retirement might someday bankrupt the state system, the Conservative government let consumers opt out of the supplementary state plan and set up private accounts. It also let employees get out of company pensions and use part of their payroll taxes to fund their new "personal pensions."
With global stock markets booming and the government backing the shift, the plan looked like a winner. Insurance-company salespeople persuaded many people to switch out of workplace plans to private accounts. They argued that the market payouts from these accounts would be so large it would more than make up for the loss of employer contributions. Trouble was, that advice often wasn't sound. Reason: The returns from the market would have had to have been gigantic to make salesmen's scenarios work.
Regulators in the 1990s cracked down on what was called the "mis-selling" scandal, and insurers had to compensate customers who'd done worse by switching to private pensions. So far, payments have totaled £13 billion, about $24 billion at current exchange rates.
The Labor government has tightened regulations since 1997, but this has done little to restore confidence in personal pensions. When pension law changes, as it does frequently, insurers must notify customers whether they still come out ahead with individual accounts. In late 2004, the Association of British Insurers mailed six million copies of a brochure with a photo of a smiling young woman on the cover, which advised older people it had become "very unlikely" that personal pensions would match what the state offers.
Given all the new rules, insurance-company salesmen complain it takes as long as 12 hours to sell a personal pension. But ever since the bursting of a stock-market bubble in 2000, fewer people have wanted the private accounts anyway, despite stocks' 2003 rally. Last year, Watson Wyatt's Mr. Yeo estimates, 200,000 of the roughly three million personal-pension holders canceled their private accounts and made contributions to the state pension instead. He expects another 200,000 to do the same this year.
As the British experience shows, if individual accounts get a bad reputation, it's hard to clear up the problems and sustain support for privatization.
Chile
Chile's private accounts are a pioneering program that's studied by economists from around the world. Assets in the private accounts amount to $54 billion, nearly equal to two-thirds of national output.
Workers' full contribution, 10% of pretax wages, is deposited in individual accounts. In addition, about 2.3% is deducted from wages for administrative fees and insurance. Employers don't make matching deposits. A traditional program still exists for some older workers.
Chile's achievement owes a lot to some unique conditions. Gen. Augusto Pinochet's harsh military regime didn't have to worry about dissent when it sold state businesses and cut spending, to build the budget surplus needed to switch newer workers to private accounts.
Chilean markets also helped. In the first years after the private accounts began in 1981, Chile was battered by a financial crisis that caused high interest rates. These helped funds invested in debt. As rates fell in ensuing years, pushing up bond prices, the funds booked big capital gains. Later in the 1980s and 1990s, the funds benefited from equity investments amid a big stock rally. From 1981 through 1995, funds returned an average of 12.7% a year.
The U.S. economy and financial markets are in a quite different position than Chile's were when it adopted private accounts. U.S. interest rates, while slowly rising, are near historic lows. And while Chile then had a promising emerging stock market poised for a boom, the U.S. is a mature market that enjoyed a giant run-up over two decades starting in 1982.
Now Chile's returns are coming back to earth. From 1996 to 2004, they averaged about 6.5%. Large fees charged by fund managers, amounting to more than 20% of the total deposited, have also taken some of the glitter from the privatization system. "This program was imposed at the point of a bayonet," says Juan Correa, an auditor and account holder. "And today, I have to pay management fees even if I lose money."
The government has jawboned fund managers to reduce fees. But the costs are one of several reasons there's widespread evasion of the system. Only about 60% of workers contribute to it, roughly the same percentage as before private accounts. Some who do contribute underreport wages to avoid taxes, studies show. Evidently many would rather pocket their earnings rather than sock part of them away.
That said, the program has been embraced by the center-left governments that have ruled Chile since its return to democracy 15 years ago. In Chile, the program is considered a solid success, though hardly the "miracle" it is sometimes portrayed as in seminars and studies by proponents overseas.
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