Crises and Pensions:Crises and Pensions:Lessons from the Global Lessons from the Global

Financial CollapseFinancial Collapsebyby

SEBASTIAN EDWARDSSEBASTIAN EDWARDSUniversity of California, Los AngelesUniversity of California, Los Angeles

May, 2010May, 2010

The three pillars of Chile’s The three pillars of Chile’s economic successeconomic success

Openness and international competitionOpenness and international competition Strong institutions and the application of Strong institutions and the application of

the rule of lawthe rule of law Pension system based on capitalizationPension system based on capitalization

Crises and pensionsCrises and pensions

One of the most remarkable aspects One of the most remarkable aspects of Chile’s privately run of Chile’s privately run

capitalization system is that it has capitalization system is that it has survived the crisis very well…survived the crisis very well…

Much better, indeed, than what some Much better, indeed, than what some international commentators and “international commentators and “gurusgurus” ” have been arguing in speeches around the have been arguing in speeches around the

world…world…

Value of Chile’s five funds in Value of Chile’s five funds in relation to the pre-crisis levelrelation to the pre-crisis level

-7%

0%

7%

14%

21%

Fondo A Fondo B Fondo C Fondo D Fondo E

Valor en comparacion a peak 11-07

Valor en comparacion a peak 11-07

Any serious analysis of the relative Any serious analysis of the relative merits and de-merits of the privately-merits and de-merits of the privately-managed capitalization system has to managed capitalization system has to

compare it to the alternative: compare it to the alternative: government-run regimes…government-run regimes…

… … and when this comparison is and when this comparison is done, the result are illuminating…done, the result are illuminating…

Government-run, defined-benefit, Government-run, defined-benefit, pension systems are in very serious pension systems are in very serious

shape… shape…

The main reason is that public The main reason is that public sector debts have exploded…sector debts have exploded…

Debt to GDP Ratio

0

20

40

60

80

100

120

USA Germany Belgium France Canada Greece Italy Portugal UK

Debt to GDP Ratio

The main reason is that public The main reason is that public sector debts have exploded…sector debts have exploded…

Debt to GDP Ratio

0

20

40

60

80

100

120

USA Germany Belgium France Canada Greece Italy Portugal UK

Debt to GDP Ratio

In contrast, Chile’s debt-to-In contrast, Chile’s debt-to-GDP ratio is only 9 percent!GDP ratio is only 9 percent!

… … worse yet, prospects are not worse yet, prospects are not good, going forward… projections good, going forward… projections

for the USA…for the USA…

0.0

25.0

50.0

75.0

100.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Net Debt as a Percentage of GDP Gross Debt as Percentage of GDP

… … and this is the “good news”… in and this is the “good news”… in reality things are much worse…reality things are much worse…

Government-run systems are not “marked to market”Government-run systems are not “marked to market” The recent strength of government bond prices hide The recent strength of government bond prices hide

the tremendous risks involved (although the Greek the tremendous risks involved (although the Greek crisis is beginning to change things)….crisis is beginning to change things)….

The true debt of government run programs are The true debt of government run programs are “hidden costs”; contingent liabilities that are not “hidden costs”; contingent liabilities that are not captured by conventional accounting…captured by conventional accounting…

It has been calculated that the “hidden” social It has been calculated that the “hidden” social security and Medicare debt in the US is security and Medicare debt in the US is 59 trillion 59 trillion USD ! USD !

In California, the government-run In California, the government-run pension system is in serious pension system is in serious

crisis…crisis…

It has recently been estimated that It has recently been estimated that the true shortfall of the three most the true shortfall of the three most

important government-run important government-run pension schemes exceeds half a pension schemes exceeds half a

trillion dollars…trillion dollars…

This has affected the lives of This has affected the lives of millions of people that have seen millions of people that have seen their net salaries reduced, and their net salaries reduced, and

their contributions to the pension their contributions to the pension system increase… system increase…

... it has even happened to modest ... it has even happened to modest

university professors…university professors…

Hasta la vista, baby!

Where is my pension?Where is my pension?

The recent European crisis of the The recent European crisis of the PIIGSPIIGS shows that unfunded pension shows that unfunded pension

systems can exacerbate a serious systems can exacerbate a serious crisis…crisis…

Unfunded pension obligations…Unfunded pension obligations…

0

100

200

300

400

500

600

700

800

900

Portugal Italy Ireland Greece Spain

Unfunded pension obligations as percentage of GDP in 2009

Unfunded pension obligations as percentage of GDP in 2009

From the news:From the news: ““Reforms in Greece’s pension system envisage Reforms in Greece’s pension system envisage

30% cut in the pensions and increase of the 30% cut in the pensions and increase of the retirement age with up to 15 years, Greek retirement age with up to 15 years, Greek Ta Ta NeaNea daily reports”. daily reports”.

““Greece on Sunday announced more austerity Greece on Sunday announced more austerity measures … through 2012, to be achieved measures … through 2012, to be achieved through … pension pay cuts…”through … pension pay cuts…”

Bond yields: Greece, Portugal and Bond yields: Greece, Portugal and selected Latin American countriesselected Latin American countries

2

3

4

5

6

7

8

9

10

11

12

Greece 5 year Mid Yield Portugal 5 year Mid Yield Brazil Yld to Mat

Chile Yld to Mat Mexico Yld to Mat

Other important Other important contributions of the contributions of the

privately-administered, privately-administered, capitalization systems…capitalization systems…

Contributions to long-term Contributions to long-term economic growth…economic growth…

Capital accumulation, requires savings

Productivity growth requires innovation and dynamic capital markets…

A well-designed privately-managed A well-designed privately-managed system – that is, one with a system – that is, one with a

“solidarity pillar” “solidarity pillar” – also helps – also helps reduce poverty and inequality…reduce poverty and inequality…

Challenges and pending Challenges and pending reforms for capitalization reforms for capitalization

systemssystems

A modest list of possible A modest list of possible improvementsimprovements

Encourage voluntary savings for old ageEncourage voluntary savings for old age Design properly company-sponsored and Design properly company-sponsored and

company-funded programscompany-funded programs Increase coverageIncrease coverage Implement mechanisms that deal with Implement mechanisms that deal with

people’s behavioral inertiapeople’s behavioral inertia Involve independent and informal workers in Involve independent and informal workers in

the systemthe system

Eliminate gender discriminationEliminate gender discrimination Increase the offer of investment fundsIncrease the offer of investment funds Add flexibility to portfolios (make Add flexibility to portfolios (make

investment limits flexible)investment limits flexible) Regulate the exposure of savings to risk Regulate the exposure of savings to risk

during years prior to pension decisionduring years prior to pension decision Implement a safety net that, without Implement a safety net that, without

discouraging contributions, provides a discouraging contributions, provides a minimum pension to poorer people (joint minimum pension to poorer people (joint with negative income tax)with negative income tax)

Reduce management costsReduce management costs Improve risk managementImprove risk management Design rules that reduce exposure to Design rules that reduce exposure to

sudden dips in market in period sudden dips in market in period immediately preceding retirementimmediately preceding retirement

SummarySummary The merits of a system is proved in difficult The merits of a system is proved in difficult

times, in times of crisestimes, in times of crises The privately-managed, capitalization based The privately-managed, capitalization based

pension regimes have shown to be robustpension regimes have shown to be robust To be sure, in many countries they could To be sure, in many countries they could

improve with reforms aimed at greater efficiency improve with reforms aimed at greater efficiency and better risk managementand better risk management

However, when compared with government-run However, when compared with government-run regimes the result are, by and large stellarregimes the result are, by and large stellar

Contrary to what some gurus have said, we need Contrary to what some gurus have said, we need more capitalization regimes, not fewer more capitalization regimes, not fewer