The article talks about two different aspects of the problem. The first is that, contrary to predictions, the "social safety net" part of the program has continued to grow over the 20+ years since the introduction of private accounts. This is partly a transition issue. The private account system is mandatory only for people entering the workforce after 1980. Thus, at this point, all; of the people required to participate are 40 or less and have yet to retire. Many people over 40 today, especially those who were over 40 in 1981 probably opted to stay in the defined-benefits program either for the security it provided or because they did not have enough time to accumulate the amounts in private accounts necessary to provide benefits comparable to those provided by the defined benefit option. In addition, though, the biggest source of the problem with the social safety net growth is that approximately 50% of Chile's work force is outside the pension system altogether "because they earned much of their income in the underground economy, are self-employed, or work only seasonally."
Given these factors, the continuing increase in social safety net costs may not be all that surprising and almost certainly is not a reason to reject privitization as unworkable.
The other problem the article identifies is more of a concern. The article indicates that the program has not worked even for middle class people who have participated for 20+ years:
Even many middle-class workers who contributed regularly are finding that their private accounts - burdened with hidden fees that may have soaked up as much as a third of their original investment - are failing to deliver as much in benefits as they would have received if they had stayed in the old system.According to the Times, "The[se] problems have emerged despite what all here agree is the main strength of the privatized system: an average 10 percent annual return on investments." (Emphasis added)
Dagoberto Sáez, for example, is a 66-year-old laboratory technician here who plans, because of a recent heart attack, to retire in March. He earns just under $950 a month; his pension fund has told him that his nearly 24 years of contributions will finance a 20-year annuity paying only $315 a month.
"Colleagues and friends with the same pay grade who stayed in the old system, people who work right alongside me," he said, "are retiring with pensions of almost $700 a month - good until they die. I have a salary that allows me to live with dignity, and all of a sudden I am going to be plunged into poverty, all because I made the mistake of believing the promises they made to us back in 1981."
As the times indicates, part of the explanation for Mr Saez's disappointment lies in absurdly high administrative fees. By my rough estimate, administrative fees would have to run 5% or more to chew up a third of the a participant's contribution over 20 years; much more than that for shorter terms. This is at least 20 times the fees associated with a typical no-load index fund in the United States. Thus, this part of the problem is clearly avoidable.
Even so, though, a more detailed look at Mr Saez's case -- at least as described in the Times, does make one important point that bears emphasis: compound growth is "magical", but it requires time. Most of the benefit of compounding comes in the last 5 years before retirement.
Take this extrapolation of the facts provided by the Times as an example. Mr. Seaz contributed 10% of his salary to his private account for 24 years, beginning in 1981 at age 37. He had a final pre-retirement salary of $950 per month, or $11,400 per year. The Times doesn't provide any information on his earnings history, so, for the sake of example, assume his salary increased 5% per year over the 24 years between 1981 and 2004. Under this assumption, his salary would have been about $3500 in 1981. Assume also a 10% return on investment (the average reported by the Times) and an expense rate of 0.2%. Under these assumptions, Mr. Seas would have accumulated just under $50,000 in his account by 2004. At an annuity rate of 8% (2% less than the actual average rate of return for the previous 24 years), this would have provided Mr. Seas with a monthly annuity of $416, or 44% of his 2004 salary, still well short of the $700/month that the Times implies he would have been entitled to had he stayed in the defined benefit program.
Admittedly, this disparity seems odd. But it is explained, in part at least, by the fact that Mr. Seas had "only" 24 years in the program, starting at 37 and retiring at 61. If he had been 15 years younger, so that he had 39 years in the program when he reached 61(and holding all other assumptions constant), his account would have totaled $260,000, which would provide a monthly annuity of $2,174, 110% of his new final retirement salary of $1,975/month, and nearly double the maximum benefit payable under the defined benefit system. In short, Mr. Saez's problem -- apart from fees -- is that he was not in the program long enough.
This story illustrate some important points about privatization. First, and most obvioulsy, fees have to be kept low. Given the limited range of investments being contemplated by most privatization proposals, the huge amounts of money involved and the very, very limited overhead that will be involved in managing these accounts, limiting fees to less than 0.2% should be an easily attainable goal.
Second, you can't take a person in the middle of his working life out of the defined benefit plan entirely and expect him to do as well with private accounts as he would do under the defined benefit system. There has to be a phase-out. Suppose for instance, that a typical working life were considered to be 38 years (age 22 to 60). Mr. Seaz had worked 15 of those years before starting with the private accounts. If his annutiy from the private account had been supplemented with 15/38ths (39%) of the $700/month benefit he would have been entitled to had he stayed in the defined benefit system, his total retirement income would have be $691/month -- $416 from his own annuity and $276 per month in defined benefits -- almost exactly equal to the benefit for a comaprable person in the program.
Third, while Bush is wrong to claim that there is a crisis in Social Security, he is absolutely right to argue that, if we are going to move to a system of private accounts, now is the time to begin. Private accounts do have the promise of providing enormous benefits to retirees -- but only if they are investing in such accounts for 30 years or more. Thus, at any given point in time, the only people who can be taken entirely out of the system are those who are under 30. If we wait another 10 to 15 years to begin taking the under-30s out of the system, the number of people over 30 -- who must remain in the system to some degree -- will be far larger than it is today, making the transition costs all that much higher.
Finally, it will take at least 30 years or more to phase out the current system entirely. During that entire period, social security benefits will place an ever increasing burden on general revenues as an ever growing number of people are outside the defined benefit system and no longer paying social security taxes. These costs will be enormous and will fall primarily on our children -- unless, as part of the transition, we oldsters agree to take up a part of that burden by accepting a reduction in the benfits we expect our children to pay us.
Conceptually, there are three groups of people implicated by this issue: Those 45 and older (us), those 20 to 45 (our childen), and those 0 to 20 (our grandchildren). Privatization offers enormous benefits for our grandchildren, but securing those benefits is going to require sacrifice by the other two groups: higher taxes/national debt for our children and higher taxes and reduced benefits for ourselves. To my mind, though, the sacrifices are worth it.
(Note: I am not talking about the poor here. I consider the poor to be a separate issue. As a part of any reform, I would support a provision guarnteeing to all retirees benefits equal to the greater of (1) the benefits to which they are entitled given their contributions or (2) 125-150% of the poverty level for persons their age).
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