Political and Social Effects in Chile of that Country's Pension System Testimony of Mark M. Klugmann (Director of the International Center for Pension Reform) before the Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Securities June 25, 1997 Mr. Chairman, distinguished members of the subcommittee: My name is Mark Klugmann; I am director of the International Center for Pension Reform. I am a U.S. citizen who has lived in Santiago, Chile since 1989. Immediately prior to that I lived in Washington, D.C., where I served on the White House staff under Presidents Ronald Reagan and George Bush. As a result of the great international interest in the Chilean pension model, many public policy-minded visitors from the United States have visited the ICPR in Chile. Typically, along with curiosity over the origins and mechanics of the Pension Savings Account (PSA) system, they also wish to know what the popular reaction in Chile has been to this innovation and what have been the collateral social and political effects. It is fair to say that the PSA system has served as an important anchor for Chilean democracy, a moderating force in historically divisive national politics and a central element promoting restraint and prudence in the execution of economic policy. During the transition from the military government to democracy, memories were still fresh of the economic crisis produced under the government of Salvador Allende. There was a palpable fear on the part of some Chileans that the return to elected government could bring about the return to demagoguery, populism, Marxism and finally economic collapse. In that climate of doubt, and in the presence of some politically motivated efforts to fan the flames of that fear, the PSA system was one of the elements which served to defuse those concerns. The new reality in Chile was clear: The economic future was not up for grabs in the election. No government could resume the role of being owner of the economy because that role had, in essence, been taken over by the Chilean workers through their pension accounts. Moreover, even if it was the case that some fearful Chileans were disinvesting as a hedge against the potential economic risks of the transition, which by itself could have provoked instability in financial markets, any tendency to sell shares was offset by the normal financial inflows of the pension system. It is also fair to say that, the PSA system has de-politicized the issue of pensions and eliminated from Chilean political campaigns the demagoguery and fear-mongering around retirement issues that had once been employed as a matter of course. Under the new system there is no room for "pension check politics" because workers who own the individual savings accounts that will fund their individual pension understand that the results of elections will neither take away their pension nor automatically increase it. Thanks to the PSA system, some 75 percent of Chilean households are the beneficial owners of equities. As a point of comparison, in the United States today, over 20 years after Peter Drucker proclaimed the arrival in our country of what he termed "pension fund socialism", only 37 percent of U.S. households are the beneficial owners of equity shares, according to a study cited in BusinessWeek magazine. In part because of this factor, the PSA system has shown the capacity to promote a broader vision and greater realism in the formation of government economic policy. In all countries, financial markets instantly calculate the future impact of economic policy. But in the case of Chile, the reaction of the markets is immediately connected to the pocketbooks of the voters. As a result, government policies that would produce economically destructive results are less likely to be implemented. The nature of the PSA system is that it creates a self-interested, majority constituency for the general health of the economy - namely all of the workers. And, very importantly, it gives the members of that constituency not just a stake in the economy (which fundamentally everyone has), but a simple and clear way to measure and feel the impact of policy on the economy. Perhaps more pointedly, elected officials are permanently aware that the voters will instantly see and feel the verdicts of the markets, creating an important political counterweight to interest group pressures. Taking an example from U.S. history, much has been written about the harmful policies initiated in the late 1920s and early 1930s that led to the Great Depression, among them the Smoot-Hawley Act. It has been documented how the financial markets reacted to and anticipated the disastrous effects that passage of that tariff would have. Today in Chile, there is a feedback mechanism that can convert market signals into democratic consensus. Families get regular statements that show them the performance of their pension account, a significant portion of which is invested in the stock market. In addition, under the PSA system, Chile has been able to avoid the common practice in many countries where governments direct pension money towards politically favored uses, not toward the best risk-adjusted return. The PSA system has also helped to blunt the edge of electoral appeals to class envy. In Chile, where workers are also capitalists, elections tend to produce moderate results. An important test of public acceptance of the PSA system came in 1995, when all Latin American financial markets suffered the so-called Tequila Effect, following the Mexican crisis. The decline in the Chilean stock market that year produced the only period where the PSA's have suffered a negative return, declining 2.5%. For some observers the experience of 1995 demonstrated the resilience of the PSA approach and helped to illustrate the macro-economic stability afforded by the system. The then finance minister of Argentina, Domingo Cavallo, commented that the only reason that Chile was not as hard hit as the other Latin countries was because of its pension system. He candidly added that he wished that Argentina had made its own move to such a system sooner, in order to have avoided some of the hardship it was then forced to go through. Nonetheless, the fact is that Chilean workers, who had been enjoying real positive returns of 12% per year, on average, were stunned to see the numbers in their account statement grow smaller for the first time. Immediately some political groups, long hostile to the PSA concept sensed an opportunity. They launched a campaign to change the structure of the PSA system. A national debate ensued. Defenders of the PSA system, among them the government superintendent and José Piñera, architect of the system, went on television to explain the causes of the situation. The fears of the public were allayed, and the attempt to weaken the PSA system quickly died. The episode served to demonstrate the fundamental confidence the people have in the system and the capacity of relatively unsophisticated people to grasp the common sense nature of the PSA concept when they are given the facts. From that time on there has been no talk of going back. In a practical sense, the PSA system has been ratified by two successive elected governments and by the confidence the public has shown in the pension structure. An interesting test of the acceptance of the system came in the municipal elections of 1992, when José Piñera ran for city council in one of the poorest and historically most radical districts in the country. An article in The Wall Street Journal reported on the race in a piece titled "Chile’s Man from Harvard Campaign in Santiago’s Harlem." [The cited article is included for the record.] In the campaign, the Left attempted to make the pension system an issue. The voters in that district may have been low-paid workers, but through their pension accounts they were the owners of their own savings, they were invested in the economy. To the surprise of nearly everyone, when the votes were counted, the founder of Chile’s pension system had come in first. It is interesting to note that by the following year, when Piñera ran as an independent candidate for the presidency on a platform of expanding the concepts of the PSA revolution to other policy areas, he received a much higher than expected vote. [A related article is included for the record.] By that time, none of the major parties even questioned the wisdom of the PSA system. It is possible to conclude that in addition to seeing the merits of the pension system, electoral strategists may have also made the political judgment that there were no votes to be had opposing the pension system. Perhaps some wiser heads have concluded that touching the pension savings accounts of the voters is, indeed, the third rail of Chilean politics. What is certainly true is that today in Chile the national system of Pension Savings Accounts is a matter of complete normality, as much a part of daily life as is the private delivery of health care coverage in the United States. Though I might add that Chileans seem to find it easier and more straightforward to choose their PSA than do many federal workers in Washington when they must choose their medical insurance provider during open season. The advertising messages of the various PSAs are viewed as matter-of-factly as, for example, the advertisements of competing providers of long distance telephone service. But with the difference that what is being promoted on a permanent basis in Chile is savings, self-reliance, and responsible financial planning. Hence by a variety of means it is possible to observe the broad public support that the PSA system has achieved in Chile, the degree to which it has become a normal feature of daily life, the contribution that the system has made in promoting democratic moderation, the positive effects it has engendered in building a more productive and participative economy, and the contribution it has made to promote a culture of savings.