The 17-year military dictatorship of General Augusto Pinochet has left an indelible mark on the history of Chile. Even as the Latin American nation celebrates this year its 200th anniversary of independence from Spain, that dark period remains first and foremost on peoples’ minds.
There can never be any justification for human rights abuses, but through the years Chile has nevertheless stuck to and expanded the free market model introduced during the Pinochet regime. Years of political consensus on key economic policies, sound fiscal and monetary management and a continued focus on structural reform have resulted in the kind of sustained economic growth that shielded Chile from the worst of the global financial crisis.
“Chile’s resilience is based upon the country’s strong macroeconomic framework and in addition to the management of fiscal and monetary policies, successive governments have always abided by stronger structural issues with respect to governance and the rule of law,” says Theresa Paiz, who covers Chile for credit rating agency Fitch Ratings.
But it wouldn’t be possible to discuss Chile’s economic success without speaking about the role that pension reform has played. The system of privatized pensions introduced by Pinochet, which put workers in charge of their own retirement finances and replaced a severely crippled, state-supported pay-as-you-go defined-benefit model, resulted in radical changes to the Chilean economy. It led to an impressive growth in the domestic savings rate, which in turn catalyzed financial market expansion and innovation. It has been, Paiz says, one of the greatest contributors to economic growth in Chile over the past decades.
The system of private retirement accounts in Chile is a model that successive governments, regardless of their political bent, have continued to support. Through the years, Chilean administrators have worked on the model in order to increase its efficiency and performance, says Edward Whitehouse, pensions expert in the social policy division of the Organization for Economic Cooperation and Development (OECD) in Paris, taking steps wherever necessary to address any flaws or weaknesses. Whether that means increasing the number of investment funds available to the public; honing the risk/reward profile of each one; educating the general public on retirement finance or tackling the issue of high administrative charges, the pension system, Whitehouse says, is at the heart of the Chilean state.
Because of its importance to the Chilean economy and the work that has been done upon it through the years, the private retirement system is much more resilient to shocks and it held up relatively well during the financial crisis compared to retirement systems in other countries. “Chileans had built up large balances in their accounts over the years, so that helped, and Chile is a resource rich country—its largest export is copper—so the country didn’t suffer from an economic crisis in the way that other nations did,” Whitehouse says.
Nevertheless, certain core weaknesses had come to the fore in recent years, not least the fact that a significant number of Chileans—non-working women, the self-employed, and the very poor, to cite a few examples—had not been contributing to the system and were therefore not getting any disbursements from it. Chile set about in 2008 to address these flaws, undertaking the most serious reform to its retirement model in a long time through the introduction of a new publicly financed program—a “solidarity pillar” designed to support those who had been excluded from contributing to a private account, either because they didn’t contribute or they simply couldn’t contribute.
The reform—which came into effect during the tenure of former president Michelle Bachelet and her center-left coalition government—relies on public funding to finance more than half the total pension for those individuals who had fallen through the cracks of the privatized system. The rest of the population, meanwhile, will continue to pay into and rely exclusively on on their private retirement accounts. The reform’s end goal is to redistribute funds from the more financially comfortable segment of the population to the needy, Whitehouse says, and it is a move that was deemed necessary by the authorities since despite Chile’s economic success, there are still large gaps between the country’s haves and have-nots.
“The government has launched this as a big public program designed to alleviate poverty and we believe it makes sense because they are insuring lower income workers against different kinds of risk and giving them a guaranteed minimum income in retirement,” Whitehouse says. “In essence, the richer segments of the population are not getting anything from the new program, and they are the ones who, being best able to cope with risk, are taking on more of it while those who can’t cope with it that well don’t have to take on that much.”
According to Estelle James, former director of the Pension Flagship Course at the World Bank in Washington, D.C., and a consultant to the World Bank, USAID and other organizations, the problem of contributions that cannot be collected from the many individuals who don’t regularly work in the formal labor market is common to contributory schemes in all low- and middle-income countries where the informal sector is large. However, the approach taken in Chile’s 2008 reform raised some issues, not least the threat of moral hazard, which could compromise the sustainability of the contributory system.
Since 2008, seniors in the bottom 60% of households have received a tax-financed public benefit, which is reduced as the pension from their own account rises. This implicit tax on accounts could lead workers to try to contribute less, by entering self-employment or jobs in the informal sector, James says, and if this happens it could undermine the defined-contribution scheme.