Korea considers the Chilean Model

By Harry Ha

A non-governmental organization set up by the Korean Confederation of Trade Unions (KCTU), and some other civic groups, recently announced that more than 2 million Koreans had already signed up to its campaign to boycott the payment of premiums for the state-run National Pension and Health Insurance Systems.

The administration of President Kim Dae-jung has pressed ahead with a bold plan to expand the pension scheme to all Koreans aged between 18 to 60 from April 1, this year, in efforts to speed up the development of a welfare state, covering not only salaried workers, farmers and fishermen, but also self-employed urban residents.

Why then, should an apparently good welfare system, like our pension scheme, face such strong resistance from the very people whom the scheme is supposed to benefit?

All state-run pension systems, based on the principle of income redistribution, as is ours, are condemned to collapse, sooner or later, just like a huge ``Titanic hitting an iceberg.'' This idea was expressed by Jose Pinera, a Ph.D. in economics from Harvard and former Chilean Minister of Labor and Social Security, now one of the most prominent pension reformers in the world.

Corroborating Pinera's ``Titanic theory,'' the State Auditing Agency of Korea announced in November that the national pension fund will dry up in 2032, while the Public Servants Pension fund and the Private Educators Pension fund will be exhausted in 2001 and 2032, respectively, the Army Pension fund on the other hand, became insolvent long ago in 1973, due to excessive expenditure.

The pension crisis is a global phenomenon and a permanent headache for Northern European countries, which once boasted of having developed the ideal welfare state systems under the famous slogan of ``from the cradle to the grave.'' They are now agonizing over what can be done to cure the so-called ``Dutch disease,'' now spreading to the rest of the world.

Is there then, any valid and viable solution to this social and global epidemic? I say yes! But, as a pre-condition to understanding the new pension system, we need to be ready to accept a complete ``paradigm shift,'' which consists of the private pension saving account system (PSA), based on the Chilean model.

In 1925, Chile became the first nation in the Western Hemisphere to follow the example of Bismarck's Prussia and create a state-run welfare system, and, 10 years later the U.S. implemented its Social Security scheme, based on the same concept.

However, more than half a century later, in 1980, Chile approved a law (D.L. 3500) to replace the government-run pension system with a privately administered, national system of Pension Savings Accounts, which began to operate on May 1, 1981 (Labor Day in Chile).

After 18 years of operation, the results speak for themselves. Pensions in the new private system are no longer doomed to become bankrupt, and their rates of return are 50 to 100 percent higher than they were in the former system of income distribution.

The resources administered by the private pension funds amount to around 42 percent of Chile's GNP. By improving the functioning of both the capital and the labor markets, pension privatization has been one of the key initiatives that, in conjunction with other free-market oriented structural reforms, has pushed the growth rate of the Chilean economy upwards from the historical average of 3 percent a year to 7.0 percent on average during the last 14 years.

Under Chile's PSA system, what determines a worker's pension level is the amount of money he accumulates during his working years. Neither the worker nor the employer pays a social security tax to the state. Nor does the worker collect a government-funded pension. Instead, during his working life, he automatically has 10 percent of his wages deposited by his employer each month into his own, individual PSA.

A worker may contribute an additional 10 percent of his wages each month, which is also deductible from taxable income, as a kind of voluntary savings scheme. A worker chooses one of the private Pension Fund Administration companies (``Administradoras de Fondos de Pensiones,'' AFPs) to manage his PSA. These companies can engage in no other activities and are subject to government regulations intended to guarantee a diversified and low-risk portfolio and to prevent theft or fraud.

A separate government entity, the highly technical ``AFP Superintendency,'' oversees the system. Of course, there is free entry into the AFP industry.

Each AFP operates the equivalent of a mutual fund that invests in stocks and bonds. Investment decisions are made by the AFP. Government regulation sets only guidelines and maximum percentage limits both for specific types of instruments and for the overall mix of the portfolio.

There is no obligation whatsoever to invest in government or any other type of bonds. Legally, the AFP company and the mutual fund that it administers are two separate entities. Thus, should an AFP go under, the assets of the mutual fund _ that is, the workers' investments _ are not affected.

Workers are free to change from one AFP company to another. For this reason there is competition among the companies to provide a higher return on investment, better customer service, or a lower commission.

Each worker is given a PSA passbook and every three months receives a regular statement informing him how much money has been accumulated in his retirement account and how well his investment fund has performed. The account bears the worker's name, is his property, and will be used to pay his old age pension (retirement ages: 65 for men and 60 for women).

Self-employed workers are not compelled to enter the pension system but they can voluntarily adhere to any AFP, while army and police personnel are excluded from the system due to the state security problem, having their own pension scheme.

The Chilean PSA model, created by Dr. Jose Pinera, has already been adopted by such countries as Peru, Argentina, Colombia and Mexico, and it is being studied by the World Bank, as well as by the UK, U.S., Japan, and China, as a valid alternative to solve their social welfare problems.

The Chilean pension system is cited by many pension experts as the most functional model in the world, together with the Singaporean pension system. I sincerely believe that Korea could also take good advantage of this system, at a time when the government is trying to find a viable model, which would save the Korean people from the nightmare of an eventual Titanic crash.

(The writer is an international lawyer and currently the representative of Merit Investment Inc., Korean Times).



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