Tuesday, May 20, 2008

Social Security perspectives

From Chile's guy...

We had dinner with a fellow who made a real change – Jose Pinera. As Chile’s Labor Minister in the ‘80s, he completely changed the system of public pension financing and provided a model for the rest of the world. We’ll let Jose tell his story as he told it to us last night...

“A little background: You see, almost all the world’s pension systems came from the same source – Otto von Bismarck. He set up the first one in Prussia and it was later taken up in almost all the developed countries. We set it up in Chile in 1925. It wasn’t set up in America until ten years later.

“Bismarck was very clever. He offered people a pension on what is called here in France a ‘repartition basis.’ That is, all the money goes into a pot ... and you get from the pot whatever the politicians decide you can have. Bismarck offered people who retired at 65 a nice pension, for the time. Bismarck knew that the average life expectancy in Prussia at the time – this was the middle of the 19th century – was only 45 years old. So he knew he couldn’t have to pay out many pension claims. But the average person didn’t know how long he would live, so he could imagine himself living to a ripe old age and taking advantage of the public pension system...

“Well, now, everyone is living much longer, and the politicians aren’t as smart as Bismarck. They’ve promised greater and greater benefits, and even lowered the age when you can get them, so the pension systems are going broke. They’re all going broke – you can count on it...

"Recently, I was in China, for example. You want to see a pension problem ... look there. That policy of one family, one child is a catastrophe from a pension financing point of view. They’re going to have hundreds of millions of old people, and very few young people to support them.

“Anyway, back in the ’80s, I went on TV in Chile, with ideas about how to reform the pension system. I was just a young economist ... only 29 years old ... Minister of Labor.

“... I had to explain to the people what was wrong, and had to explain to them how to fix it. So, the first thing I needed to do was to win their confidence ... I took my mother’s egg timer and I held it up and I said, ‘I’m only going to talk for three minutes. Give me three minutes and I’ll explain what’s wrong with the pension system and what we’re going to do with it.’ And I told the cameraman to just cut me off after three minutes.

“This worked beautifully, because it made me look humble ... I wasn’t going to waste the people’s time with a long, windy speech like Castro ... I was just going to tell them something simple, fast ...

“They called me the Minister of the Egg Timer, but they began to trust me. And then, I went back on TV, over and over, each time for only 3 minutes, and each time with my egg timer to keep me honest ... I laid out everything ... why the system went broke, and what I was proposing to put in its place – a different system in which, instead of dumping all the money into a big pot that the government could do with as it pleased, each worker had his own personal pension account. It took some explaining. But I kept going ... each time explaining more and more.

"I had to explain, for example, that the idea of the ‘employer contribution’ is a myth. The employer just looks at it as part of his labor cost. But once you call it an ‘employer contribution,’ the employee gets the idea that it’s not really his money that finances the system and he feels he has no control over what he gets out of it anyway.

“My system is very simple. The worker makes exactly the same contribution as he did before. But it’s his own money and he knows it. And he has some control over how it’s invested. And if he dies, it goes to his family. He’s an owner of it, not just a recipient of government handouts.

“So, when I had finished laying all of this out, over a 9-month period, I then admitted that I could be wrong. ‘Maybe this won’t work as well as I think it will,’ I said. And I said I didn’t want to force anyone to go with my system. So, we decided that anyone who wanted to stick with the old system – which is the system you still have in France, and America – could do so....

"Now, guess how many people went with the new system? We thought 51% would be a victory. Instead, 95% signed up for private retirement accounts.

“And here’s something interesting. About a third of the population of Chile are leftists ... socialists, communists, or Hillary Clinton liberals. Even these people – when it came to their own money – preferred to have it in their own retirement accounts, invested in stocks and bonds, rather than in some black hole in the government accounts.

“And the best thing about this is that it turns the whole country into capitalists. Even the leftists think twice before they vote for higher business taxes or more regulations. They worry how their retirement account will be affected.

"And that’s why Chile is now the richest country in Latin America.”

A companion noticed the problem right away: “That must be why the left fights so hard to resist this kind of reform,” he said.

“Yes ... but it will come. You just have to wait until your current system goes bankrupt. And it will..."

-- via The Daily Reckoning Australia.