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DOMESTIC FINANCE STUDIES NO.67
SOCIAL SECURITY AND SAVINGS MOBILIZATION
A CASE STUDY OF CHILE
By
Christine I. Wallich
The views presented in this paper are solely those of theauthor and do not necessarily reflect the official opinions ofthe World Bank or its affiliates.
January 1981
Public and Private Finance DivisionDevelopment Economics DepartmentDevelopment Policy Staff
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Table of Contents| .. Pae
I Introduction: Savings Mobilization for Development . .
II Social Security in Chile: Its Place in Latin America,ItsBackground and Historical Development . . . . . . . . . . . . 4
The History of Social Insurance in Chile . . . . . . . . . 8Nature of the Benefits . . . . . . . . . . . . . . .. . .12Eligibility of Benefits . . . . . . . . . . . . . . . . . 15Benefit Levels ....................... 18The Cost of the Benefit Programs . . . . . . .. ... . . ..22Structure of the Financing of the Chilean
Social Security System . . . . . . . . . . . . . . . . .24The Reform Proposals . . . . . . . . .. ... . . . . . . ..32
III The Effects of Social Security on Total Savings andCapital Formation: A Survey . . . .. . . . . . . . . . . . .38
The Generation of Surpluses . . . . . .. . . . . . . . . 39Social Security Surpluses: New Savings or Not? ...... 40Effects of Social Security on Personal Savings . . . .. 43Social Insurance and Government Savings ........- 55Does Social.Secu ity Affect Business Savings? ... .. . . 56
IV Resource Allocation: An Analysis of Investment andBenefit Policies as Factors Leading to the Decapitalizationof the Chilean Social Security Fund . . . . . . . . . . .. . 59
Social Imperatives and Benefit Policies .. . . . . . .. 64Portfolio Choice and the Reserve Fund . . .. . . . . . . 72The Cousequences of the Social Imperatives
Investment Strategy . . . . . . . . . . . . . . . . . . 72The Non-Fiscal Institutions . . . . . . . . . . . . . . . 84The Choice of a Financing Mode: Pay-as-you-go
Vs. Capitalization . . .. . . . . . . . . . . . . .. . 89Pay-as-you-go: The Theoretical Case . . . . . . . . . . .90Capitalization . . . . . . . . . . . .. . . . . . . . . .95Capitalization and the Reform Proposals in Chile ..... .96
V Social Security and Lifecycle SavingsThe Theoretical Exposition . . . . . . . . . . . . . . . 102Rationale for the Lifecycle Approach in Chile ...... 105Social Security and Savings: Empirical. Evidence
for Chile . . . .. . . . . . . . . . . . . . . . . . 107Data . . . .. . . . .. . .. . . . . . . . . .... 108Estimation . . . . . . . . . . . . . . . . . . . . 111Impact on Total National Savings . . . .. . . . . 113
VI Conclusions . . . . . . .. . . . . . . . . .. . . . .. . .116
Appendices ........................... 118
Tables
Page1 Social Security Coverage in Latin America 52 Cost of Social Security as Percentage of GDP,
Selected Countries 63 Payrol Tax Rates on Employers and Emp .oyees,
Selected Countries 74 Social. Insurance Affiliation, Chile 115 Benefits Available to Social Security Affiliates 136 Pension Eligibility Requirements 157 Dependents Eligible for Family Allowances 178 Social Security Pension Levels 199 Family Allowance Levels 21
10 Distribution of Social Insurance Expenditure 2211 Dependency Ratios 2312 Sources of Social Security Financing 2413 Payroll Tax Rates in Chile 2614 Government Payments to the Social Security System 2815 Gross and Net Cash Surpluses of the Chilean Social
Security System . 6916 Gross and Net Cash Surpluses of the Chilean
Social Security System as a Fraction of Receipts .7017 Portfolio Composition . 7518 Social Security Wealth 8019 Annual Cash Surpluses of the Social Security System 8120 Portfolio Composition: Comparison Between Private
and Public Funds . 8521 Average Real Portfolio Value (Social Security Wealth)
of Public and Private Funds 8722 Financial Savings and.Labour Force Equations 109
Introduction
Savings Mobilization for Development
The savings potential of social security has long been recognized.
Surpluses generated by the system can provide an additional and - given
certain population dynamics - increasing fount of resources for the country's
development efforts. In countries where coverage is extensive and the com-
pulsory contributions of employers and employees high, the "savings" of the
social security system (defined as the difference between their annual
receipts and expenditures) can be quite substantial - in some Asiar-
countries,L/ for example, the savings amount to up to 50% of receipts,
and up to 2% of GNP.V1 The resource allocation aspects may also be impor-
tant. An actively managed pension fund will contribute to the widening of
the national capital market. The distribution of new savings generated by the
system ±s also likely to contain a far higher proportion of domestic
securities than a similar volume of savings, privately held. Social
insurance systems are also frequently important holders of r^t-.rnment
securities and provide the public sector with boundless sdurce of borrowed
funds - to be channelled with strategic development sectors.
1/ Malaysia, Philippines, Singapore, Sri Lanka and India show surplussesalmost as high, about 35-40%. Outside of Asia, countries withnotably high surpluses are Syria (55%), Egypt (60%), Costa Rica (30%)and Turkey (30%). These figures are three year averages.
2/ Malaysia (2.0 ) Philippines (0.5%), Singapore (1.4%).
-2-
While the ability of the sector to mobilize resources is not
disputed, the question of whether the savings generated through it are "'new
savings", i.e., whether the total value of national savings is increased)
remains open. For example, if household savings decline, once the system
guarantees a well provided retirement (as life-cycle savings theories would
suggest), or if the system receives net transfers which are deficit -
rather than tax-financed, the net.change in savings may be very different
from the system's savings mobilization taken in isolation.
This paper will explore the nature and impact of the social
security system on saving and resource allocation in Chile. Chile represents
an interesting case, as it is at once representative of a number of Latin
American countries, but also provides a sharply contrasting picture with
respect to coverage, methods and type of protection with many of the Asian
social security "success stories". Chile's is an old svstem, the second
oldest in Latin America (1924), and has an astonishingly comprehensive cover-
age. It is, for example, one of the very few countries to include agricul-
tural labourers and domestic servants among the affiliated. The range of
benefits is equally wide: pensions of almost all kinds, family allowances,
maternity and health care, workmen's compensation, disability and funeral
expenses are all provided.
The layout of the paper is as follows: Section I provides a
general background of the Chilean Social Security System, describing Its
history and present structure, financing, range of benefits and coverage.
A proposed reform of the system is also discussed. Section II provides a
general survey of the theoretical literature on social security- and savings.
The third section discusses the resource allocation aspects of the social
security system, and discusses the pattern underlying the investment of
the social security cash surpluses in Chile. This section also evaluates
the proposed reform of the Chilean system, whtch includes a plan to re-
establish capitalization, and discusses the implications of this plan for
resource allocation and the pattern of investment. It concludes with an
analysis of the relcive advantages of capitalized and pay-as-you-go
system. The final section treats the savings mobilization issue empirically,
and examines the likely implications of the system for national savings in Chile,through effects on household savings, using a lifecycle model of the !iodigliani-
Brumbert type and on government savings. In the concluding section, the paperpulls together the effects of the social security system on savings and the
allocation of investment, and makes a final evaluation regarding the impact
of social insurance on capital accumulation in Chile.
-4-
Section I
SOCIAL SECURITY IN CHILE: ITS PLACE IN LATIN AMERICA, ITSBACKGROUND AND HISTORICAL DEVELOPMENT
The social insurance programs of Latin America fall into two
categories, those erring by commission, and those which err by way of
omission. They appear either vastly overblown for the country's level
of development or else are characterized by very inadequate benefits and
coverage. Countries such as Argentina, Uruguay and Chile, the "southern
cone" countries of Latin America, fall into the former category. That
the extent and coverage of social security provisions in these countries
is far greater than that embodied in .egislation (and
that the programs were introduced almost 2 decades eartier) is often sur-
prising to many who expect systems of such scope to be characteristic only
of countries far wealthier.
The question of what level of development is appropriate for
the introduction of a social insurance system is still unanswered. Social
insurance, or social welfare programs are often seen as luxury which LDC's
can ill afford, since it is often held that they channel resources into
This view, however, ignores the savings mobilization potential which a
well run system will have if it is capitalized. Another view, however,
is that any wage society requires some type of income-protection scheme.
The transition from rural to urban society will be smoothed as social
programs enhance the newly required mobility of the labour force and relieve
the hardships ensuing with the breakup of the extended family. The ad hoc
types of social security which will in any case be devised in traditional
-5-
societies (extended families, many children) are often barriers to
economic change.,
By far the greater number of countries, err by omission.
The Andean countries are characterized by a relatively more unequal
distribution of income, and have far higher population growth rates.
Their programs are, therefore, restricted to homogeneous groups and have
narrow geographic coverage. As regards the benefits extended to the
population at large, these are thin in conception; the range of services
is narrow and poorly financed. The following table gives some idea of
the coverage of these programs.Table 1
Social Security Coverage in Latin America(affiliates as a percentage of the economically active population)
Argentina 67.6
Bolivia 8.4
Brazil 31.4
Chile 67.5
Colombia 14.4
Ecuador 16.1
Mexico 20.9
Paraguay 9.6
Peru 27.8
Uruguay - v
Venezuela 22.9
Source: Economic Survey of Latin America, ECLA 1973, Part 3.
-6-
The Table shows that Chile has had an astonishingly comprehensive
degree of toverage, and this has been true since the inception of the system
in 191P. It is, moreover, one of the very few countries, in Latin
America or elsewhere, to include agricultural, labourers and domestic ser-
vants amongst the affiliated. The range of benefits is equally surprising.
Pensions of various kinds, family allowances, maternity and health care,
workmens' compensation, funeral and marriage expense are all provided.
A social welfare system of such depth as that of Chile clearly
cannot come cheaply. Expenditures on social security programs amount to some 18-
19Z of GDP. This is greater than the equivalent proportions in the United
Statesl
7 Israel, Canada and the U.K., and on a par with Germany.Table 2
The Cost of Social Insurance* GDP, selected developed and developing countries
1970 - 71
Colom`iia 2.8Belgium 18.4 Mexico 3.2
Canada 14.7 Brazil 6.2
France 15.0 Chile 18.0
Italy 18.6 Israel. 9.0
Germany 17.3 1ialaysia. 3.4
Japan 5.7 Singapore 2.7
Sweden 20.6 Venezuela- 3.0
United Kingdom 14.0 Sri Lanka 3.6
United States 10.5
Source: Cost of Social Security, ILO, Geneva, 1976.
7
Chile is, on the-other hand, outspent by Sweden, Italy, Belgi=m and
the Netherlands. While some caution must be exercised with these
comparative figures, since the programs may include benefits of differing
types and varying coverages, the table nontheless provide a perspective or
the level of expenditures on social insurancd in these countries.
Chile also has the dubious distinction of having higher payroll
tax rates than almest any other country. Rates reach almost 50% of the
wage billA/Rates for the other southern cone countries are almost as high:
Argentina and Uruguay have rates of up to 33 and 45% respectively. Given
these magnitudes, it is evident that the impact of the Chilean social
Table 3Payroll Tax Rates on Employers and Employees
selected countries
employee emloyer . employee employer
Australia* 0 0 Mexico 3.75 13.0
Belgium 9.2 29.45 Brazil 8.0 15.8
Canada* 2.6 3.0 Chile 9.5 41.0
France 5.6 36.4 Israel 4.0 9.0
Italy 7.05 40.6 Malaysia 5.4 6.9
Germany 4.85 15.35 Singapore 10.0 10.0
Japan 7.35 10.0 Philippines 3.75 4.2
Sweden* 7.0 11.?7 Venezuela 4.0 8.0
United Kingdom* 5.0 6.0 Sri Lanka 6.0 9.0
United States 4.85 7.35
* Bulk of costs met by general revenues.
Source: Cost of Social Security, ILO, Geneva, 1976.
1/ This figure is an average for the system as a whole. The actual rates varyon actuality from 46-82% of wages, divided very unequally between employeeand employer.
-8-
insurance systpm,. is likely to be considerable.-A
The History of Social Insurance in Chile
The growth of social insurance provisions in Chile follows a
pattern commwn to many countries. Public employees, the civil service
and the armed forces are almost uniformly aa..rigst the first group to
obtain coverage under budding social insurance programs. Indeed, the
system was born in Chile with the creation of a pension scheme for the
Army in 1915. The employees of the state railway (Ferrocarriles del
Estado) became, in 1918, the second group for whom a pension fund was
established. Shortly thereafter, the remainder of the public sector fol-
lowed suit. All three funds were conceived initially only to provide
pension benefits rather than welfare services such as family.allowances
or medical care, and financing was rooted firmly in the principles of a
private contributory pension model. The introduction of further benefits
to protect against other contingencies was delayed for about a decade.
In 1925, the blue collar labour force was integrated into the
social security system, with the creation of the "Caja de Seguro Obligatorio",
later renamed the "Servicio de Seguridad Social", and the "Caja de Empleados
Particulares" was spawned to protect private sector white collar employees.
These funds, and all other subsequent institutions, had provisions for
retirement, health, and family allowances from their inception, unlike their
counterparts a decade earlier where the provisions were introduced piecemeal.
The distinguishing anomaly of the Chilean social insurance
system is the fact that is not, indeed a "system" at all, but rather an
anarchy of individual institutions (35 at present) each with its own distinct
regime of coverage, benefits and contribution rates. Each of these institutions
-9-
purports to represent a specific sector of the populace and to be attuned -
to and to serve its needs and requirements. Thus, there are funds for
manual and white collar employees, for banktemployees, for shipping employees,
employees of gas companies, water companies, municipalities, sporting clubs
and racetracks. Administratively, these funds are in no manner related.
While some of these specialized institutions existed before 1925";/,
many of them were or,ginally a part of the larger institutions, and broke
away from them when it was plain that they could do better on thl.ir own,/
Buchanan (1963) notes that services provided through earmarked, or segregated
funds will be greater than when subscribers are financed through general revenues
akieartng with the budget process allocating expenditures to various subgroups.
In the thilean case, it is plain that the many splinter groups of employees
have indeed benefitted from the establishment of their own funds. By
providing benefits and catering to a small, homogeneous group and thereby
limiting redistribution, these funds were able to, and still do)offer a much
wider range of benefits and services that what can be offered by the institu-IL 4 ' -
tions serving the country's The subdivisions into optimal
"clubs" has left the blue collar institutions at a disadvnstage. Their finan-
cial solvency has been jeopardized and the services they provide have been
increasingly restricted.
The 9ilean social security system is clearly an improvised
arrangement, its manner of development reflects the'responses to pressures
from influential employee groups. Perhaps, it is best seen as an outgrowth
1/ Banking Funds, Gildemeister and other private corporate pension funds.
2/ 1937, The Merchant Marine; 1941, racetrack employees.
- 10 -
of the social/syndical process in Chile.
The three earliest, largest semi-fiscal institutions still
dominate the picture in Chile; together they insure about 70% of the labor
* force, and approximately 90% of the labour force affiliated to any ins-
titution at all is affiliated to one of these three, Between these three
and the next largest, there is a quantum leapt i4s the table below shows, L£jlargest fund (Armed Forces) covers only 2.1% of the total affiliated
population: the fifth, 1.4%.. 97% of all contributing workers belong to
the largest blue collar institution, the "Servicio de Seguridad
Social" (S$S , henceforth). The fund for private sector employees (E2PART)
extends coverage to approximately 85% of the total affiliated white
collar labour force in private industry. 65Z of covered public employees
are members of the "Caja de Empleados Publicos" (CANAEMPU). The benefits
extended by the threo funds to contributing and retired members and their
dependents, reach about. 73% of the total pv;ul,.atibr
At the very bottom of the range are the funds with some few hundred
members. These are the small, privileged private funds, such as the Bank
Funds and the Racetrack Employees' Funds, whose affiliates comprise a select,
homogeneous group. These differ from the broader institutions not only
by the nature of their membership, but by the. nature of their revenues.
2/While the semi-fiscal funds are supported. solely via payroll levies,- the
private funds also receive revenues from various federal extise taxes which
are earmarked for them.
1/ Seguridad Social #98, p.73.
2/ Recently many of them have also been receiving public subsidies.
Table 4
Chile: Social Insurance System Affiliation
1974
Blue Collar Sector # of Affiliates %Servicio de Seguro Social 1,594,000 65.8Merchant Marine Workers' Fund 25,812 1.0Municipal Workers of the Republic Fund 14, 798 0.5Central Trainers and Jockeys Fund 3,402 0.1Water Co. Workers' Fund 700 0.02Trainers and Jockeys Fund, Concepcion 105 0.004Trainers and Jockeys Fund, Antofagasta 59 0.002
Private Sector, White Collar EmployeesPrivate Employees' Fund 361,000 14.9Merchant Marine Employees' Fund 19,390 0.8Journalist Employees' Fund 12,358 0.5Bank Employees Pension Fund 8,624 0.4Saltpetre Corp. Employees' Fund 4,267 0.2Bank of Chile Employees' Fund 2,091 0.08United Breweries Employees' Fund 1,156 0.04Water Co. Employees' Fund 1,150 0.04Gildemeister Corp. Employees' Fund 950 0.04Hippodrome of Chile Employees' Fund 825 0.03Gas Co. Employees' Fund 693 0.02Sporting Club of Santiago Employees'Fund 586 0.02Valparaiso Sporting Club Employees'Fund 392 0.01Antofagasta Sporting Club Employees' Fund 114 0.004Merchant Marine Customs Agents' Fund 107 0,004Concepcion Sporting Club Employees' Fund 98 0.004Hochschild Corp. Employees' Fund 94 0.004
Public Sector, White CollarPublic Employers' Fund 291,615 12.0National Defense Fund 45,000 1.8Policemens' Fund 34,767 1.4State Railways Fund 24,971 1.0Banco del Estado Employees' Fund 9,140 0.4Municipal Employees of the Republic Fund 5,014 0.2Municipal Employees of Santiago Fund 2,000 0.08Central Bank Employees' Fund 1,560 0.06Municipal Employees Valparaiso Fund 320 0.01
Total 2,422,253 100.0%
Source: Seguridad Social, Estadlsticas 1973/74.
- 12 -
Nature of the,Benefi,ts
The Chilean social insurance system covers primarily dependent
employees. The self-employeed, including those having their own profes-
sional sociaties (doctors, lawyers, accountants, etc.) are generally not
covered although they are eligible for affiliation as independents. Within
the class of dependent employees, a distinction has always been made in Chile
between "obreros" or wage/blue collar labour, and "asalariados ", white
collar employees on a salary, however meagre this may be. This distinction
has been carried over into the types of social insurance provision available
to them, as the previous table shows. There are frequently two funds for the
same, employee sector; for example the Municipal Workers' `und, and Runici-
pal Employees Fund. The two groups receive different levels of benefits
(which is in the nature of things as many benefits are related to past
earnings levels) and also distinct kinds of benefits. Eligibility
requirements for the various benefits also differ amongst the funds. These
are usually much stricter for the larger funds. especially the Servicio de
Seguro Social, which has almost always operated under such financial cons-
traints, due in large measure to the splintering off of the better-off em-
ployees groups to form their own Cajas. The following table indicates the
nature of the benefits extended to the three primary employee groups. Though
not shown in the table, the nonfiscal institutions generally provide the
same range of benefits as does the public employees fund, CANAEMPU.
- 13 -
Table 5
Benefits Available to Affiliates of the Chilean Social Security System
3 Funds
Benefits SSS EMPART CANAENPU
PensionsOld Age ,o xx xxDisability xx xx McSeniority -x xxUnemployemnt xx
Other Pensions (Survivors')Widows' xx xx xxOrphans' xx xx xxChildrens' xx xx XXMothers'
XXFathers'
cxC.Siblings' tM.-c
Other BenefitsFamily allowances xx 3 XXLife insurance xxFuneral expenses ax XX XXOther misc. X-s xx
Health Care xx xx xx
SOURCE: Seguridad Social #98, p. 39.
- 14 -
The range of benefits authorized by the different regimes
indicates a profound discrimination amongst the social groups, which is
essentially what the membership in these three funds corresponds to.
Public employees are by far the most favoured group, receiving life
insurance and provided for in the event of unemployment. Blue collar
workers are not offered either of these benefits, nor are they eligible
for retirement after 'year of service', i.e. for a seniority pension.
This latter kind of pension, as we shall see subsequently, has encouraged
1/the early retirement amongst the professional classes.-L/ The scarcity of
administrative and technical manpower in Chile makes this quite a
serious problem. As regards the other types of pension, those received by
family members in the event of the death of the worker, the public employees
fund is again the most liberal. All dependants at time (of death, even
brothers) are eligible for support.
All three institutions provide family allowances to their members.
However, there are differences between the institutions, which arise primarily
from (1) the number of. beneficiaries eligible for the allowances and (2) the
size of the allowance itselfA', both discussed in the following pages.
Health care is also provided in some manner by the three funds.
For SSS members, it is provided in kind, through the Servicio Nacional de
Salud. The quality of care is generally good in urban areas, but its distri-
bution is poor, and rural affiliates often do not have access to the health
service clinics.
1/ See Davis, (1964).
2/ Until 1974. In that year, the 'Fondo Unico de Asignaciones Familiares'was created,.which equalized family allowances across all institutions.
- 15 -
Eligibility for Benefits
*The 'overview of the social security benefits extended to the
various groups holding membership in the funds exposes only some of the
inequities of the system. Discrimnation of an equally fundamental nature
is inherent in the eligibility requirements for these institutions and
often remains disguised. There are two broad categories of benefits for
which eligibility requirements are important: the entire pension system
and the system of family allowances. Pension eligibility may be determined
by (1) age, (2) years of service, or (3) post-retirement income, and (4) for
disability pensions, the degree of disability. Eligibility for family
allowances, until the recent reform, varied with respect to the family
members defined as dependents, with respect to amn income ceiling on,the
dependents' earnings, etc.
The following table shows the eligibility requirements for
different types of pension:Table 6
Pension Eligibility Requirements
Years of OtherFund Minimum Age Contributions Reouirements
Old Age SSS 65 - men 800 weeks - men "density55 - women 500 weeks - women requirement"
EPART 65 - men 1 year --55 - women
CANAEMPU 65 - men 10 years55 - women
Seniority, SSS not given
EMPART 55 - men 35 years - men -50 - women 30 years - women
CANAEMPU 50 - men 30 years - men --45 - women 25 years - women
Disability SSS less than 65 5 - 0 weeks "total disability"
EMPART less than 65 10 years "definitive"
CANAEMPU 3 years "incapable of work"
Source: Seguridad Social 198, p.54.
- 16 -
Clearly there is much discrimination between the groups arising
from these variable eligibility requirements. Breaches of vertical equity
arise in innumerable ways. The required period of contribution for retire-
ment pensions ranges from 1 (EMPART) to 15 (SSS) years. With respect to
seniority pensions, the range of necessary years of affiliation is 25-35,
and the minimum age goes from 45-55. For the blue collar class, it is,
of course, 65, since they are not allowed early retirement pensions.
These features are very important for the net incidence of social
insurance programs. The shorter the period of affiliation, the lower will
be an individual's accumulated paid-in contributions at the time of retire-
ment. The result is that those with shorter periods of affiliation have
"paid" less for a given level of retirement benefits than others whope
affiliation was of longer duration.
A feature which puts much of the blue collar class on the margin
of social security who otherwise would be covered, is the existence of
concurrent requirements. They are required to have (1) a minimum number
of years of contributions, (2) a minimum density of contributions (years
of contributions divided by years of affiliation),- and (3) minimum age
requirements. In practice, owing to cultural and socioeconomic factors, this
group fulfills such requirements with difficulty. An indication of the num-
ber of insured entirely at the margin of protection, is given by the
7, following. In 1965, 15,437 pensions were granted by the SSS. 7,963 requests,
or half as many, were turned down. Of these rejected applicants, 6,500 ful-
filled the requirements of the EMPART for retirement on the same grounds
of old age.-
1/ Thus, a worker fulfilling the 800 weeks of contributions requirement, ifhe has been affiliated to the caja for 40 years, may not in fact fulfillthe simultaneous density requirement, namely 1040 (20 yrs.x52) weeks ofpaid contributions.
2/ Annuario de Estadisticas de Seguridad Social, 1965.
17 -
The system of family allowances, exhibits many of the same featuresso evident in the pension system, and can be equally faulted for the discri-
mination inherent in the way benefits are distributed. Unlike a generalized
welfare system where such allowances are generally means-tested, so that the
recipient state of need determines the levelT of benefits, until the 1974
reforms , the funds in Chile each administered their own family allowances,.
and there was no overall redistributive element. Over the system as a whole,
these allowances were positively related to income.
An important difference between the institutions is the number of
dependents eligible for allowances: for public sector employees, all legiti-
mate descendants and forebears, and natural children are eligible. It almost
seems impossible to imagine a relative not included here.
Table 7 shows the dependents who are covered, in principle, by
the various institutions.
Table 7
Dependents Eligible for Family Allowances
by Institution - 1968
Relation: SSS EMPART CANAEMPU
Wife x xSick husband - x xLegitimate and adopted children x x xNatural children - x xGrandchildren x x xMother x xFather - x xNatural mother - - xWidowed mother x Xe xSiblings - - xAll other descendants not mentioned above - xAll other forbears - x x
Source: SS #98, p.69.
- 18 -
The greatest pradtical difference perhaps between the blue and white
collar funds is the provision of family allowances to natural children
in the latter. For sociological reasons, the incidence of this is likely
to be much.higher among the worker class. However, much more important
to recognize is the prominence of the common law arrangements, which are
very common within this group, perhaps 30%. of all 'marriages' being re-
cognized under the common law. By standards other than those of the SSS,
offspring of these unions are not considered illegitimate. Hence, this
particular exclusion is likely to weigh heavily against the ) class.
The exclusion of parents too, generates vertical inequity. Especially
where pensions are inadequate and eligibility requirements difficult to
fulfill, the affiliated worker is likely to have a dependent parent. It
is in this class where the extended family system is still strong (precisely
because the transition from retirement provision via intergenerational
transfer has not been completed), where there is likely to be a greater
need for relief on this score than in the other institutions.
The final eligibility-related inequity arises from differences
in the concept of 'disability'. For SSS affiliates, this must be "absolute"
for receipt of a pension; lesser degrees are required of the affiliates of
MeART and CANAEMPU.
Level of Benefits
Because,in general, pension benefits are fairly directly related
to past earning levels, it is in the nature of things that within each
fund, there be no overt distributional implications. However, taking the
three funds together, a different picture emerges, and the benefit structure
becomes regressive. This is the result of four things: (1) the proportion
- 19 -
of the salary which is replaced by the pension (replacement ratio), (2) the
actual base salary on which the pension is based (i.e., average of last three
years or five years' salary, etc.), (3) the different timing and extent of
the pension revaluations made for inflation-and (4) the ceiling, if any,
tmposed or post-retirement earnings, that is, the effective marginal tax
rate or retirement income.
The table shows the immense variability of the pension benefits
received by affiliates of the various institutions. Pensions range from
50% of monthly wage to up to 133% of the past salary (for a public employee
with 40 years affiliation).Table 8
Social Security Pension LevelsBase and Proportion of InflationSalary Replaced by Pension Adlustment
Old age: SSS 50% of monthly salary. annual, indirectlywage indexed to wageincreases of over 15%.1
EMPART 30 of average salary annual, indirectly(last 36 months) for indexed to "sueldoeach year of work. vital" increase of
more than 10%.1
CANAEMPU 35 of average salary annual, directly(60 months) for each wage indexed.year of work.
SenioritZ: SSS None
EMPART Total average salary, same as abovelast 60 months.
CANAEMPU Total average salarylast 36 months. same as above
Disability: SSS 50% of monthly salary same as above
EMPART 70% of average salary, same as abovelast 60 months
CANAEMPU 70% of average salary, same as abovelast 36 months
Source: Seguridad Social, #98.
- 20
Pensions of the SSS are adjusted annually by the amount of
the average wage increase of this group, if it exceeds 15% over the past
year. With respect to the entire system of adjustments, this is the only one
which is not directly related to variatious in the price index.1'
Adjustments for EMPART.affiliates are also made annually, (if the
"sueldo vital", directly linked with prices, has risen by over 10%). Pensions
are adjusted by between 100 and 0 percent, depending on the size of the
pension.
A special subgroup of EMART affiliates is entitled to the so-called
"pension4s perseguidores". That is, pensions are indexed to some percentage
of the salary increases of the corresponding employee in active service.
Because of trends in public sector remuneration over the past 2 decades,
this arrangement results in a greater adjustment of pensions for this group
of retirees than for any other.
Those institutions which have no indexing provisions for pen-
sions- follow guidelines set up in the'Fondo de Revalorizacion de Pensiones.'
these. are broadly similar to the provisions for EMART retirees.
Family allowances, the other cornerstone of Chile's social insurance
system, exhibit the same diversity with respect to eligibility and levels of
benefits amongst the granting institutions. Their value is little related
to the statd of need in which the recipient and his dependents.find themselves
since each institution sets its own level. These allowances for the Banco de
1/ Seguridad Social, #98, p.41.
2/ The bulk of CANAEMPU affiliates, Merchant Marine and the racetrackemployees.
- 21 -
Chile employees were 5 times greater in 1968 than those granted by the SSS,
In 1974, a reform was instituted,l/ establishing a "Sistema Unico de
Prestaciones Familiares," (consolidated system of family allowances) through
which uniform benefits (and identical taxes)are now provided.
Table 9
Family Allowances, by Granting Institution
Constant March 1977 pesosS SS EMPART CANAEPU
1966 34.94 200.0 *79.11
1970 91.54 240.81 138.38
1974 81.69 88.22 113.77
1975 74.25 74.25 74.25
1976 86.80 86.80 86.80
1977 111.39 111.39 111.39
Source.: 1960: Orlandini (op.cit.) p.60, 1970: Orlandini, 1977,mimeo, p.139.
1972-74: Annuario Estadistico 1976, p.161.
1975-77: Superintendencia de Seguridad Social.
The equalization of family allowances has led to significant gains
in the real value of blue-collar workers' receipts relative to those of the
nonmanual class. In absolute terms, the allowances are below the peaks they
reached in the early 1970's during the Popular Unity Government, but they
are well above the level of allowances in the 1960's. For the white collar
class, the decline has generally been quite large.
1/ DFL #307, Feb. 1974.
- 22 -
The Benefits: Their Cost
Pension disbursements are by far the largest category of expenditure,
and the proportion has increased sharply since 1960. This is to a very large
Table 10
Earmarked Destinations of Funds of the Social Insurane-System% of total expenditure
Pensions Family Allowances Health Care Indemnity Unemployment Total
1969 34.3% 37.8% 22.6% 4.4% 0.7% 100%
1963 41.3 31.4 21.3 5.5 0.7 100
1964 41.4 30.8 21.8 5.3 0.7 100
1965 43.1 29.7 21.6 4.9 0.1Z 100
1966 47.2 27.7 17.3 5.4 0.8 100
1970 47.3 28.3 16.8 4.6 0.9 100
1971 49.3 23.7 19.0 5.1 0.4 100
1972 49.6 23.2 19.9 4.9 0.4 100
1973 47.0 21.5 24.1 4.5 0.5 100
1974 41.5 29.6 21.8 4.3 0.7 100
1975 44.9 26.4 19.9 5.4 1.2 100
Source: Seguridad Social #98, P.74.(Years 1960-65) Costo de la Seguridad SocialChilena, 1977 (years 1968-77).
degree a refleation of the steady increase in the ratio of passive (pensioned)
affiliates to active contributors; a ratio which has risen £rom 15Z in 1960
to 31% in 1975. The ratio has also risen much faster than ratio of older
(over 65) inhabitants to the economically active population, as the following
table shows.
Table 11
Dependency Ratios
(1) (2) (3)Ratio of population 65+ Dependency
Ratio of Passive to to economically active Ratio (65+;Active Affiliates. popul4tion under 65 20 - 65)
1945-6 2.3%
1950 4.5 11.75% 7.5%
1955 9.7 12.8 8.0
1960 14.9 14.2 8.4
1965 26.0 16.1 9.0
1970 28.U 17. 7 .9.1
1975 31.0 17.4 9.7
2000 17.4 10.3(Proj ected)
Sources: Demographic Brief, IBRD 1977 (Col. 3)Odeplan (Col. 2), and Finanzas, Bancos y CajasSociales, 1946-70 (Col. 1).
While the former has more than doubled in 15 years, the latter has risen
- by less than a quarter. T.his is due to a mixture of early retirement among
those who are affiliated, and to a base of affiliates which is not growing
as rapidly as the labour force in general.
The sizeable proportion of resources directed towards erstwhile
members of the labor force has implied a consequent declind in the disburse-
ments on family allowances and health care.Given the age structure of the po-
pulation, it is likely that that pensions will continue to be the most costly
aspect of the social insurance system.
- 24 -
The Structure of Financing of the Chilean Social Insurance System
The Chilean system is financed in the so-called tri-partite
mainer: the income derives from contributions from affiliated members
and their employers, and from the state. This is in direct contrast to the
U.S. system where the-pensions of the social security system are purely
-ontributory. In the system of tripartite financing, the government
contribution refers of course to its contribution qua subsidy, not its
contribution qua employer.
Over time, there has. been a tremendous shift in the distribution
amongst these sources, as the table below indicates. The employers' share
Table 12
Sources of Social Security Financing
1/ InvestmentEmployee- Emloyer State Income Other Total
1940 37.0% 32.0% 17.0% 14.0% - 100%1960 22.0 46.0 21.0 5.0 5.9 1001965 -19.8 41.6 34.0 1.8 7.8 1001968 23.0 41.1 31.8 1.3 2.0 1001970 22.9 39.4 34.2 1.3 2.2 100.1971 20.6 37.5 37.1 1.1 3.7 1001972 19.2 38.2 38.2 1.1 3.3 1001973 18.2 37.8 40.2 1.5 2.3 1001974 15.4 48.7 32.4 0.9 2.6 1001975 16.3 46.5 32.2 1.6 3.4 100
Sources: 1940-60 - P. Gregory, IBRD Chile Economic Report, forthcoming
1965-75 - Costo de la Seguridad Social Chilena, Superintendenciade Seguridad Social, 1977, p. 2 1.
1/ Includes government contribution qua employer.
- 25 -
and that of the state have increased dramatically, while that from
investment income has dwindled from 14% in 1940 to 2% in 1975. The
Airst shift reflects the changes in benefit policies of the funds,
introduced in the 1950's. These led to an explosion of payroll tax
rates as well as a growing need for public stibsidy. Payroll taxes on.
employers have increased 8 times since 1952 - employees'taxes five
times.
The table below gives some idea of the extent of this payroll
tax explosion. Rates range from 41.5 to a high of 79.6 _
1/ Payroll tax rates of this magnitude raise inevitable questions aboutshifting and labour displacement. The issue has been treated extensivelyin Aninat (1971) "The Elim.-nation of Payroll Taxes for Social Security:Estimation of its Iw?act on Employment" and (1976) The Income Effects ofthe Payroll Tax on Various kinds of Labour Markets: The Chilean Case"and in Kornevall"A Change in the Financing of Social Security and itsEffects on Employment" (1977). Both approach the question via theproduction function, and use elasticities of substitution which rangefrom 0.6 to 1.0. The effect on employment has been estimated as a 6-ll%(Kornevall) increase in the number of new jobs which would be createdwith the elimination of payroll taxes and an 8 to 25% increase (Aninat1971).
26 -
Table 13
Payroll Tax Rates of Chilean Social Security Funds
Employee Tax Employer Tax TotalBlue Collar Sector
Servicio de Seguro Social 7.3 48.0 55.3Merchant Marine Workers' Fund 12.0 47.5 59.5Municipal Workers of the Republic Fund 9.0 53.0 61.0Central Trainers and Jockeys Fund - -Water Co. Wovr9<rs' Fund 15.0 61.8 76.8Trainers and Jockeys Fund, Concepcion - -Trainers and Jockeys Fund, Antofagasta - - -
P4ivate Sector, White Collar EmployeesPrivate Employees' Fund 11.8 50.2 62.0Merchant Marine Employees' Fund 16.0 47.58 63.58Journalist Employees' Fund 12.0 48.8 60.8Bank Employees' Pension Fund 14.5 50.5 65.0Saltpetre Corp. Employees' Fund - -Bank of Chile Employees' Fund 14.5 51.0. 65.5United Breweries Employees' Fund - -Water Co. Employees' FundGildemeister Corp. Employees' FundHippodrome of Chile Employees' Fund 8.0 46.8 54.8Gas Co. Employees' Fund * 16.0* 47.8* 63.8*Sportiug Club of Santiago Employees' Fund 8.2 46.6 54.8Valparaiso Sporting Club Employees' Fund 8.0 46.8 54.8Antofagasta Sporting Club Employees' Fund - - -Merchant Marine Customs Agents' FundConcepcion Sporting Club Employees' Fund - -Hochschild Corp. Employees' Fund
Public Sector, White CollarPublic Employers' Fund 18.0 31.5 49.5National Defense Fund 15.5 29.7 45.2Policemens' Fund 16.0 31.5 47.5State Railways Fund 8.5 33.0 41.5Banco del Estado Employees' Fund 15.0 60.0 75.0Municipal Employees of the Republic Fund 15.0 45.0 60.0Municipal Employees of Santiago Fund 16.0 63.6 79.6Central Bank Employees' Fund 14.5 56.08 70.6Municipal Employees Valparaiso Fund 15.0 62.0 77.0
* 1968 rates.
- 27 -
Throughout the period, investment income has been negligible.
Although the funds were all originally expected to be fully capitalized,
by 1950, the switch to the "pay-as-you-go" basis had already been comple-
ted. This change was not due so much to a conceptual evolution, but was
the response of the institutions to the difficulties of maintaining
their reserve fund intact in the inflationary environment. The inadequate
capitalization of the surpluses was also due to the investment policies fol-
lowed by the institutions,.and later to the investment guidelines codified by
by the government. (1952). These policies themselves had been largely res-
ponses to pressures from affiliates, who wished to see the surpluses diverted
back to them, via loans and the like, rather than invested in the economy
at large. The switch to a pay-as-you-go scheme was thus in the nature
of default. The inflationary environment and poor investment choices led
to a s.4.tuation in which capitalization was simply no longer feasible.The financial contribution of the government is three-fold,
(1) It makes a direct contribution to the system in its role of employer.
(2) It also pays a direct subsidy and (3) it transfers the proceeds from
a series of taxes to certain. institutions for whom they are earmarked.
- 28 -
This high proportion of government subsidy is in part a
reflection of the way the benefit structure developed. As the institutions
grew to accomodate larger numbers, or amplified their range of benefits,
they were in general, unable to raise the revenues required to finance them
via additional employer and employeoe contributions. With respect especially
to the CANAEMPU, it is ironic that this public sector institution was intro-
duced precisely to free the Treasury from all obligations (other than qua
employer) in the social security sphere. According to their original
conception, the public sector institutions, and indeed all institutions,
were intended to be self-sufficient. The size of the government subsidy to
them is an indication of their inefficacy as independent agencies based on
principles of private insurance.
Table 14
Government-Payments to the Social Security SystemConstant 1958 EO , millions
Year Total Direct Payments as indirect subsidyContribution Subsidy Employer (taxes & special rates)
1970 349 85.0% 9.2% 5.8%
1971 511 88.0 7.0 5.0
1972 549 89.0 8.0 2.0
1973 417 89.0 7.7 3.3
1974 549 70.0 27.0 2.8
1975 492 69.0 18.0 3.0
1976 346 70.0 27.0 3.0
Source: The Cost of Social Security, 1977.
29
A problem of quite some notoriety in some Latin American
countries which arises out of such tripartite arrangements is that the,
government, qua employer or otherwise, may be quite lax about fulfilling
its obligations to the system. This is especially true in Bolivia, for
example, where the compliance of the government in meeting its obligations
has been on the order of 15Z.1/ Similar abuses by the corporate sector
have also been common. Outright failure to pay is less frequently en-
countered than are late payments, often with such a lag that the real value
of the liability is reduced substantially. Corporate remissness has often
been overlooked by the authorities in order to avert financial crises
which might develop if businesses were forced to meet these major tax
obligations.-/
Such evasion does not appear to be widespread in Chile. Family
allowances are paid directly by the employer; for medical care,. the employee's
card, with up to date tax stamps affixed, must be shown. In both cases, it
is in the employees lintere3t to see to it that full up to date coverage is
maintained for them. It is thus only in the realm of pensions that evasion
is common. While allegations.are frequent, there are no figures estimating
this.
1/ Reviglio, 1967
2/ The problem with permitting this is that the government sacrifices itscontrol over some financial flows in the economy and its selectivity ofdetermining who should and who should not receive relief is reduced.From a macroeconomic point of view, the implications are much moreserious. Permissiveness with regard to major tax obligations leads toa situation in which the government increases its own subsidy to thesystem.and its deficit which in turn fuels inflation. The higherrates of inflation themselves encourage and facilitate tax remissness,touching off another cycle of deficit and inflation.
- 30 -
To sum up, the Chilean social insurance system has many short-
comings. The major factors contributing to its weakness are
interrelated, and all owe their existence to the organizational
form which the system has developed. The primary weakness is equity.
The range of benefits authorized by the various regimes indicates a pro-
found discrimination amongst social groups. Inequities of an equally
fundamental nature are inherent in the eligibility requirements for these
benefits. Other inequities arise from the degree of protection which the
various groups receive against inflation, a source of inequity which
frequently remains disguised.
The diversity of institutions is also at the heart of the
financial crises facing the funds, and in turn, contributes to the equity
failings. The fragmentation in the 1930's of the Seguro Obligatorio and
EMPART, and the withdrawal of the better-off worker groups left the "catch-
all" institutions quite destitute; and the remaining affiliates, almost
uniformly eligible for minimum pensions,continued to drain the fund. The
Servicio de Seguro Social responded by laying down increasingly demanding
eligibility requirements - longer years of inpayments, concurrent require-
ments and the like. The insolvency and reduced benefit levels in turn
accelerated the withdrawal of affiliates to other, better paying institutions,
leaving the Seguro Social with the genu`, :-, 'insurables'.
The final drawback of the Chi>.-X.;/stem is its absolute cost.
Administrative costs are very high, on the order of 11-14% of the funds'
total income. This is a result of the endless duplication of administra-
tive superstructures for each of the 35 institutions, each with its own
accounting., legal, actuarial, medical, investment, revenue collection and
31
benefit distribution departments or offices. The other side of the costs'
picture is, of course, the extensive nature and coverage of the benefits.
While this is an overt choice, and owes itself to publicly legislated
policy and not to the fragmentation of the system per se, the diversity
of the funds has made cost-control and any effective cost-accounting over
the system as a whole very difficult. Consolidation of accounts and com-
parability studies are the task of the Superintendencia de Seguridad
Social. Nonetheless, since numerous institutions do not come under its
purview 1/, even here, there is no easy means of accounting for the costs
of the system as a wholes.
In addition to the difficulties of evaluating the impact of the
system as a whole, fragmentation has also made it quite impossible to have a
directed national policy with respect to social security.Throughout the
system's history, syndical lobbies and pressure groups have pressed for
benefit changes on behalf of their affiliates. And it has been on an indi-
vidual basis that these requests have been heard and granted2-'. Seldom
were changes obtained by one group extended to other institutions. By now,
most of these improvements have become entrenched, and the contractual nature
of the benJ-its is generally recognized. Affiliates have what is known
as goacquir.ed rights" and "legitimate expectations" with respect to the be-
nefits their fund authorizes. In short, this situation makes a general
policy covering all institutions quite impossible to achieve, without
an or.vxrhaul of the entire system - which what is proposed in the reforms,
1/ The National Defense Funds and the Banking sector institutions, forexample.
2/ This applies to the semi-fiscal funds only. The smaller hunds haverelative autonomy regarding their operations, and do not requireCongressional approval for new policies.
- 32 -
discussed on,the following page.
The present distribution of expenditures and payroll leviesis quite certainly not one which generates maximum social benefit. Theabsence of a global strategy for social security is perhaps the most costlymistake made by Chilean social insurance designers. While the new benefitpolicies of the 1950's and 1960's did overtly state the policy to increasebenefits for the poor, the orientation was belied by the continued exis-tence.of the 35 institutions and the inequities to which this inevitably led.The piecemeal, patchwork approach to reform could not cure the basic problemwhich was at the root of the system's high cost, inequity, and financialprecariousness - namely the diversity of the 35 independent institutions.The Reform Proposals
The poor performance of the system in the past and the inequitiesof the different benefit schedules has led the present government to proposea fundamental reorganization of the social security system. The purpose isto standardize the system for all affiliates and across all worker groups,as well as to reestablish its financial solvency.
While the range of benefits and protection will be broadly similarto what is currently available,- coverage will be broader: the entireeconomically active population will be covered, including the self-employed.The reform also contemplates sweeping changes in the organizational structureof the system. To replace the present Cajas, the government proposes to licenseprivate corporations to administer benefits. And unlike the present Cajasthese corporations will be nationally based, and have nothing to do with theaffiliates' occupational status. Affiliation to the system will be compulsory,but choice of fund discretionary.
1/ Since these benefits differ by institutions, affiliates of some will findtheir eligibility curtailed - others, broadened.
33-
The range of benefits each of the funds is obliged to provide
will be identical, and fixsId by law. With respect to all nonpension
benefits (family allowances, unemployment, disability, etc.) the funds
will operate essentially as administrative arms of the central social secu-
rity agency, the newly created "Caja de Compensacion de Fondos de
Reparto". The corporations will collect payroll levies and pay out the
uniform benefits and clear any deficits or surpluses with the central
agency. The only difference between the funds will be the levels of pension
which they authorize; their investment performance will determine this.
The entire pension scheme represents a radical departure from
the past. Unlike the presont system, each affiliate will have his own
account, into which will be credited the lifetime stream of employee and
employer payroll levies plus the interest which the corporation pays on each
account. Since the pension granted upon retirement is based on the value of
the accumulations in each account, it is hoped that this will reduce the
evasion of payroll contributions, which some alle ge to be rife in the pre.-
sent system because pension levels are a function of the past five years'
earnings alone, employers and employees frequently colluding to evade the
tax liability. The investment performance thus determines the level of
pensions each fund can grant, and thus provides the only basis of competi-
tion amongst the funds, since workers will be induced to seek affiliation
to funds with superior performance.
Other elements of the reform include identical payroll tax rates
and retirement ages for affiliates to all institutions. Two types of minimum
pension will be granted for those whose actuarial pensions fall below a
34
certain level. The first will be the 'sufficiency level pension' in which
the pension will be based on the 10 best earning years.- The second will
be "minimum pensions" which will put an absolute floor to the level of the
actuarial pension. A fourth type of pension - assistance pensions - will
also be available to those who have not fulfilled the eligibility requirements,
and will be charged directly to the government.
The reform envisions worker-participation in the funds' management,
although plans for this have not been spelled out. At the same time, all
corporations will be subject to government regulation and their performance
carefully monitored. The permissible portfolio will be determined by the
authorities. At present, these include only the Central Bank's 'indexed'
savings certificates' but it is expected that this will be broadened to
include all public bonds, highly rated equity in private corporations, deben-
tures and bonds. Fixed assets, real estate or any type of income earning pro-
perty will not be permissible. The hope is that the diversification of the
portfolios will help stimulate and deepen the capital market. The government
also intends to guarantee a minimum retur 2/on tne pension base - whether
to the funds or to the affiliates is not quite clear, - so that if the funds
fail to earn this, the affiliates need not suffer unduly. A guarantee fund
will also be established to cover pension liabilities in the case of bankruptcy.
1/ The actuarial pension could fall below this if earnings (and, therefore,contributions) fluctuate greatly from year to year.
2/ At present, a 3% real rate of return is proposed.
35
In sum, the proposed reform resolves many of the problems
of the present system. It deals with the equity issues and proposes a
financial program which promises, at least on paper- to make the system
autonomous. The new plan is expected to be no more costly than the old, and
payroll tax rates will be the same as, on average, they are today.
Nonetheless, there are aspects of the plan which
The primary one is the investment-competition envisioned by the
reformers. There is the ever-present danger that fund managers may over-
extend themselves, taking on riskier securities with a higher return, in
order to attract affiliates. Moreover9 it ia not entirely clear how-the
worker movements from one institution to another will be accomplished. The
thinness of the Chilean capital market makes this an important consideration -
since the corporation may have to liquidate large sums in the event of a large
scale shifts of allegiance. Even if the accounts are transferred directly
from one institution to another, the funds will have to liquidate these
accounts unless assets in the specified amount are transferred directly. In
this case, their valuatiou,among other things, becomes a problem. Other
details which the proposals do not spell out clearly is the initial capital
subscriptioii of the funds, i.e., whether these will be genuine private corDo-
rations with shareholders, or whether the government will put this up.
The absorbtive capacity of the capital market is another factor
which appears not to have received sufficient attention. At present (1975),
l/ The assistance pensions will require public subsidy, and it is possiblethat the suffic4pncv pensions - if they are granted frequently, maybe a draa- in che bystem.
investible surpluses of the social insurance system are $50-70 million.
The estimated surplus a.n the new system i8 about 4% of taxable payrolls,
or $130-170 million a potential tripling of the funds to be invested.
Since at present, 100% of the surplus is it±ested in government bonds,
the impact on the private securities matket will be even greater, and
should be examiaed with great care.
Finally, the reform is unusual in that it inverts the usual
insurance pact, in which a private insurance corporation sells a contractual
benefit paclcage for a predetanrined premium/price. Here, the investment
performance of the firm is crucial because the firm's ability to provide
the contracted benefits depends on it. How well it earns also determines'
its profits, but this is a risk the firm bears. Not so in this case, where
the risk is thrust upon the insured, who contract for an unspecified benefit
package, at a predetermined cost. Thus, the affiliates are a party to the risks
of investment, and sink or swim with their corporation. The orientation, in
short,is quite unusual and manywould say that this privatised set-up is not
at all appropriate for a public social security system. Workers who contribute
equally to a compulsory retirement program should receive identical pensions -
not suffer the consequences of variegated financial management of the various
funds. Within the realm of private business, it is in the nature of things
that individuals, using the information of their disposal, make choices, and
if these are poor, or the information imperfect, take their lumps in the
market. However, it is riot for government to sponsor such dealings.
1/ Information from Superintendencia de Seguro Social.
37
To sum up, while the decision to standardize the system and
its benefits is laudable and long overdue, many doubts remain about the
desirability the investment plan, on social grounds discussed above. Its
feasibility is also suspect because of the thinness of the capital market
at present, and because of the difficulty of finding attractive investments
with good. earnings records in an inflationary period.
38 -
'Section II
The Effects of Social Security at Total Savings and Capital Formation:A Survey
Social security systems can be fininced either via capitalization
or on a pay-as-you-go basis. In the former, the taxes on the current econo-
mically active population are accumulated over their working lives in a
'ttrust fund", out of which pensions are subsequently disbursed. The interest
earned on the accumulating fund determines, ceteris paribus, the level of
benefits; what the retiree will get for his contributions. If the system is
actuarialy.sound,accumulations will be equal to outstanding liabilities,4 and
there will be no need for outside subsidy. Population dynamics will determine
the size of the trust fund and the ratc. at which it grows. With a closed
constant population, the total wealth of the social security system reaches
its maximum when the first generation of affiliates reaches retirement, and
levels off thereafter, as the following diagram indicates
Social Security Wealth
Employment ............ )..Retirement ;nlst Generation Accumulation../.1..ecumulation
lf Or more precisely, accumulations plus the 'interest assumption' equalliabilities.
39
With a growing population, the trust fund of the system will continue to
grow as long as each generation is larger than the one which preceded it.
A pay-as-you-go scheme, on the other hand, uses the contributions
of the present working generation to pay for the benefits to the current
generation of retired folk . However, no accumulation takes place, although
reserves are obviously maintained for unforeseen contingencies. In short,
only funded systems can mobilize savings - pay-as-you-go will generate only
temporo-y surpluses. Population dynamics are important here as well, since
the age structure of the population will determine the burden on the
working generation of financing their parent generation's retirement.
The Generation of Surpluses
Tne savings or surpluses which a social security system can
generate are a function of design factors and its extension. The first of
these is the relative emphasis given to protection against short-term
1/as against long-term risks. Since health care programs, maternity benefits,
unemployment or family allowances cannot be sensibly financed on a funded
basis, the surplus as a fraction of receipts is likely to be much smaller
when these puedominate than under a differently oriented benefit structure.
Surpluses are likely to be largest in a system which emphasizes long-term
risks such as old age, disability and death and survivorship, where the
nature of the risk pooling makes funded financing appropriate.
The matulitv of the system is a second factor affecting the
size of the surpluses. A "young" system will have vew maturing claims re-
lative to its receipts, and will'"accumulate far larger surpluses than a
system in equilibri-um. A frtiori, if the population is growing, since the
age distribution will also contribute to an excess of receipts over claims.
1/ See Financial Aspects of Social Security in Latin America for furtherdiscussion of factors affecting the size of cash surpluses.
- 40 -
The cost of administering the system also bears on the proportion of
receipts which can be saved. Many countries fix legal ceilings on administra-
tive costs, but even so, the range is wide, from 3-15% of annual receipts.
Not all of this variance is due to inefficiency: much of it is itself a func-
tion of the system's design. Short-term risks are more costly to administer
than long-term - this is especially true of public health.programs and
maternity and infant care. The extension of benefits to rural populations also
increases overheads considerably, with the need for regional offices and
duplication of personnel. In general, geographic extension of social security
programs is administratively costly.
The accuracy of the actuarial base of the system over time is crucial
to the generation of cash surpluses. If changing demographic trends and a
changing trend affiliation are not continusously incorporated into financial
plans,. the solvency of the system may be jeopardized. The rate of growth
of wages (the wage assumption) and the interest rate on reserves (the interest
assumption) must also be accurately predicted. An increase in the rate of
return on the fund's assets of 1 point can reduce the cost, over an average
span of contributiona by 25% - if wages grow faster by 1 percentage point1/
than expected, the cost of a fixed benefit package can be reduced by 13%.
Finally, there is the impact of inflation. How inflation affects the
system's liabllities as compared with its receipts, and its implications for
the rate of return which can be obtained in the social security reserve fund,
will determine the level and the trend in the cash surpluses. If benefits are
overindexed, or contribution levels fall below the actuarially planned levels,
the cash surpluses will be reduced and full capitalization becomes impossible.
Ceteris paribus, the higher compulsory contributions, and the more
extensive the coverage, the higher will be the absolute savings which the
system can generate.
l/ See New York Times, 1/8/78.
- 41
Social Security Surpluses: New Savings or Not?
A Survey of Theoretical Literature
The surpluses mobilized by social insurance institutions
need not necessarily represent net additions to national savings. The
theoretical literature has focussed on two main avenues through which the
system of social provision may induce changes which would have to be offset
against the gross surpluses generated by them. The first of these is the
impact of social security on households, who, with retirement provision
guaranteed, may reduce their own discretionary savings for retirement
(Feldstein, Munnell), their precautionary balances (should the social
insurance system offer other benefits such as health insurance or workmens'
compensation), and eliminate the bequest motive for saving (Barro) when the
system-pays survivors' pensions. The second approach has been the effect of
social insurance on government savings. Here, the focus is on the tax
aspect, not the benefit side, of the system. In a "taxable capacity" model,
payroll taxes act as a brake on the government's ability to raise further
revenues via direct taxes, and thus, curb the size of the possible govern-
ment surplus. 1 ' (Reviglio, 1967a, b) It is the balance of these and other
effects,as against the savings mobilized by the system, from which the net
savings impact can be determined. Thus, notwithstanding a decline in house-
hold or central government savings, total savings need not decline, provided
the loss is fully replaced by savings of the social security institutions
themselves, which will occur provided the system is fully funded. Since the
1/ This assumes that the government's marginal propensity to save 1, i.e.opposite of the "Please. Effect".
42
attributes of social security make it. a highly imperfect substitute for
private savings, the decline in private savings is likely to be less
than one for one; - the talcable capacity theory is also open to question.
Therefore, in a fully funded system, total national savings are likely
to increase. Should the government 'be able to raise more in social
security tax revenues than would be saved voluntarily, a capitalized system
will always imply higher savings rates. A decline in national savings
comes about only if the public savings of the social security institutions do
not replace the reduction which may be induced ix private savings, the most
common case being where the social security system is financed on a pay-
as-you-go manner. In short, if national savings decline, it is the fact'
that current benefits are paid out of taxes on current earnings rather
than out of an accumulated fund of tax plus interest which leads to this
decline. In a capitalized system, savings,private or government, may indeed
be reduced. But the funding simply implies a change in the form which the
savings take: they are no less savings for being in the reserve fund of the
social security institutions.
To analyze the effects of social security on saving - the
savings mobilization question/ two entirely separate questions must be
studied. The first is, of course, the extent to which the social security
system can generate surpluses . Second is the decline in government or
household saving. Only- if the annual cash surpluses- are- iarger than the
decline, if any, in personal and government savings, w4. Ll the savings in the
aggregate be increased. If the decline in savings exceeds the cash surplus,
the existence of social security will imply a decline in. total savings.
- 43 -
The Effects of Social Security on Personal Savings
Before the advent of social insurance and guaranteed retirement
incomes, a person's own savings, (or those of his children) provided his
only means of support in retirement. The question which naturally arises
is whether the introduction of social security pensions, which cover
most of the retired labour force, has done anything to change household
savings behavior.
The earliest work on social security and savings focussed
exclusively on the implications of the payroll tax for savings, rather than
the possible impact of the pension expenditures themselves. A characteris-
tic analysis 1/ suggested that payroll tax financing for social security
was far less detrimental to savings than the same revenues raised through
an income tax, since the former was levied on labour income alone; at pro-
portional rather than progressive rates, and was subject to an income ceiling.
Thus, the payroll tax burdened only those spent what' they earned - it did not
reduce the disposable income of the affluent who were held to save, rather
than spend.
analysis focusses on the implication of social
insurance benefits for savings. Harrod's (1938) "hump savings" phenomenon
held that the principal motive for saving was provision for retirement. In
this model, the savings which were accumulated during the working years would
be just sufficient to provide an individual with an unchanged standard of
1/ Musgrave and Musgrave (1976),.Shoup (196' )
44 -
living during retirement. Net saving over the life cycle was zero.
Harrod's two period analysis, subsequently formalized and extended to a
multi-petiod framework by Modigliani and Brumberg (1956) can provide an
appropriate framework for analyzing the impact of social insurance on
savings, since social security benefits and personal savings for
retirement are in many ways substitutes for one another. The discre-
tionary.savings of households could, therefore, be expected to decline
with the 'savings' implied by an individuals social insurance contributions,
because of this substitution effect.
Seymour Harris (1941) was among the first to predict a decline
in savings due to social security, although he did not formalize the mecha-
nism by which it should come about to the extent which more recent treatments
of the question have done. The context too, needless to say, was entirely dif-
ferent, since he and other early American Keynesians were concerned with an
excessive (rather than deficient) savings rate, and the stimulation of con-
sumption to reduce unemployment. Social security was hailed at this time
as a means through which a permanent lowering of the savings rate could be3I/brought about.-
A surprising result uncovered by early empirical work on the
subject was that personal savings and eligibility for social insurance and
private pensions were positively correlated. Those whose retirements were
provided for by private pension coverage had higher discretionary savings
than those entirely without pension entitlements. Katona's (1965) study
1/ Munnell (1974b), cites a reminiscence of Musgrave, quoting Keynes in1937, to this effect.
- 45 -
used a 1963 household survey carried out by the Survey Research Center
of the University of Michigan, in which a random sample of household heads
in the United States were interviewed. (Very low income groups were
excluded from the sample on the grounds that their discretion in altering
their savings-consumption patterns wias extremely limited. ) His regression
findings lent no support to the common assumption about the substitutability
of pensions and discretionary savings. Quite the contrary, private pensions
(measured as (i) expected pension income, and (ii) pension plan affiliation)
were showa to have stimulated private savings.
The Cagan (1965) study focussed on the contributory side of
pension schemes. This again was a cross-section study and used survey data
of a 1958-9 mail out questionnaire to "Consumers Reports" subscribers. His
findings once again indicated that pension coverage stimulates saving: the
higher savings rate of the covered households appeared to be at the expense
of consumer durable purchases, rather than current expenditure. Highest
saving was found amongst groups whose pensions were only partially vested.
Moreover, the relation between savings and the level of contributions was
nonlinear. When contributions were a small fraction (4-5%) of income
savings were increased; thereafter the relation levelled off gradually.
Such conclusions are paradoxical because even when the. life cycle
model is ammended for greater realism, allowing for alternate motives for
savings, bequests, etc., while the strength of the asset substitution effect
is reduced, over all, the life cycle approach should remain substantially
unaltered. There are many institutional factors which make social security
less than 100% substitutes for private savings, even though both may be
- 46 -
accumulated for the same purpose, retirement. Unlike discretkonary savings,
savings embodied in social security form are illiquid; they do not consti-
tute a reserve for emergencies, noz can they provide collateral against
which savers may borrow. They can never be paid out before retirement, and
even then, not in lump sum.form. Moreover, social security provides for
all retired persons on the basis of their incomes. Provisions are not varied
to suit individual tastes except inasmuch as income speaks for them. In
short, the social security form of 'wealth' cannot substitute perfectly for
discretionary savings. The existence of the bequest motive for saving alone
is sufficient to limit the degree to which social security wealth or savings
and own-savings are good substitutes for each other.
While highlighting the imperfect nature of the substitutability
between these two types of wealth, and noting additional motives for saving,
these points still leave the life cycle approach substantially unaltered.
Asset substitution is still likely to occur, although the tradeoff may be
reduced. How then should the observations, that those with alternate forms
of retirement protection save more than those with no expectation of a
retirement income, be explained? Katona's 1965 study suggested that "it is
conceivable that the minimal protection afforded by collective insurance plan
stimulates people to save in order to achieve a more adequate and complete
level of protection"t.l/ This was called the "goal gradient" effect, a
term borrowed from industrial psychology. In aspiration theory , success
causes individuals to raise their sights and failure to lower them. Thus,
as the first step towards retirement provision is made through the pension
plan, the prospect of a comfortable retirement suddenly seems within reach,
1/ Katona: Private Pensions and Individual Savings, Survev Research Center,Institute for Social Research, University of Michigan, 1965.
-47-
whereas earlier it had been quite a futile hope, inaccessible to the
average individual. Pension benefits could be supplemented with ones own pri-
vate savings,'and the two together could provide and adequate retirement
lifestyle, according to Katona.
Cagan explained his results via a "recognition effect", noting
that a "plan instituted am-ng a large group of workers more or less at
random, crystallizes dormant savings intentions, and :Lnduces an increase
in their own savings.- The recognition effect, by bringing about a new
awareness of retirement needs, will remind individuals of the importance of
saving on their own.
Cagan also admitted the existence of a substitution effect;
indeed this is what explains the non-linearity of the savings/contribution
relationship.and the differences in behaviour between those.belonging to
vested and to non-vested plans. With regard to 'the former, the reron-ition
effect dominates at low contributory levels, while substitution prevails
once contributions become extremely high. Vesting,on the other hand, implies
that benefits are secure, and therefore enhances the pension's value
to the household, thereby generating a more powerful "recognition" effect.
With partial or no vesting, the recognition effect is overwhelmed by the subs-
titution effects? which' accounts for the lower savings rate of non-vested.'
Cagan notes also that the income tax system, which makes it cheaper to
provide for retirement through pension plans than own savings, provides yet
another incentive to substitute the former for personal saving effort.
Nonetheless, such countervailing effects have insufficient strength to
reverse the influence of the recognition mechanism: pensions and personal
1/ Cagan, The Effect of Pension Plans on Aggregate Saving: Evidence fromA Sample Survey, National Bureau of Economic Research.
- 48 -
javing remain complements.
The'modern'economist's difficulty with each of these rationale,"goal
gradient" or "recognition" is that they cannot be modelled into the traditional theor
of cons-mer behaviour. Neither is explainable via the common garden variety
of utility maximizing model, since the hypothesized explanations have no
microeconomic foundations..
A more recent, an entirely different explanation of the positive
relation between social security and private savings has been put forward
by Barro (1974), who extends the usual life cycle utility function.
U -U(C1, C2 ... Cn)
to embrace interdependence between the utility of parents and their
children. His new utility function is
U1 w U(C,1 1 C1 2 ... Cln' U2 )
where in turn,
U2 U(C 21, C22 *. C2 nX U3 )
etc. The result is that when social security.benefits are introduced or
raised, the recipients, aware that in a pay-as-you-go scheme, this implies
higher taxes for the subsequent generation, attempt to make good by increa-
sing the size of their bequests which they leave their descendants and in-
crease their personal savings to achieve this. This sort of approach seems im-
plausible for two reasons. Firstly, it is not at all clear that on average,
people do plan to leave bequests. Secondly, even if utility functions are in-
terdependent, it is very likely that the utility from an additional unit of
parents' own consumption will be more than the indirect utility which they
- 49 -
derive from knowing that their childrens' consumption is increased via their
bequest. In fact, where technical progress increases quickly the living
standard between generations, the Barro approach may give the reverse
conclusion, since the rational parent may decrease his bequest, knowing that
even without it, his children's consumption will be very much higher than
his owxi, and the marginal utility from any bequest considerably smaller.
Finally, the degree of planning, foresight and means required are unlikely
to be found in the average saver.
The recent work of Feldstein (1974a, 1974b, 1976) and Munnell
(1974a, 1974b, 1976, 1977), firmly rooted in traditional microeconomic
theory, has put forth new hypotheses to address Cagan and Katona s obser-
vation that pension coverage stimulates personal savings. Munnell's empirical
work does not corroborate the earlier empirical findings. She emphasizes,
however, that observed savings behaviour is a function of the relative strengths
of two countervailing influences: the substitution of social security pensions
for private discretionary savings, and the inducement which social security
provides to early retirement. A priori, the direction of the net effect is
indeterminate.
Munnell(1974b) calls attention to the fact that the age of
retirement in the U.S. has dropped considerably since 1935, the year in which
the social security system wkas introduced, and that the ret,irement decision
is, therefore, probably not exogeneous, as Katona and Cagan implicitly assumed,
but itself a function of the extent of pension coverage. Though the decision
to retire is a complex one, and influenced by many factors, far from the least
- 50 -
of these is the age at which pension entitlement is acquired.
It is often thought that poor or declining health is the primary
cause of early retirementl/ - and it is tha health/declining capabilities
argument which was behind the choice of the 65 retirement age when the programs
were designed. However, once a long-term perspect is taken on this issue,
it becomes clear that poor health cannot account for the huge long-term
decline in the average retirement age: health standards have improved,
rathet than worsened. Thus, even in LDCs, where life-expectancies are shorter
and health perhaps poorer, the long-term decline in labour force participation
cannot be explained this way. In short, it is likely that social security
factors (benefits, tax on post-rotirement earnings, etc.,) account for much
of this decline.- If pension entitlement redties the average retirement
age, it lengthens correspondingly the period of retirement, and the number of
years over which life cycle saving will have to extend. The retirement
decision is thus clearly endogenous to any model purporting to describe the
household allocation of consumption and saving over the life cycle.
Once this is recognized, the saving decision acquires a dual
dimension. Not only does the existence of social security (or private pension)
retirement income become a substitute for own savings for retirement, but it
also affects the choice of the retirement age, and thus, the length of time
1/ See Social Security Bulletin, June 1971, V. Reno "Why Men Stop Workingat or Before Age 65: Findings from a New Survey of Beneficiaries" andother issues of this bulletin containing similar surveys.
2/ M. Boskin. Stanford Research Paper I7 , 1975.
-51-
one's savings have to last. These two effects offset each other, and the
net effect, which Cagan and Katona observed to be positive, need not always
be so. For example, those who retire at the established retirement age, and
who had always intended to do this in any case, there is no effect other than
that of asset substitution. The retirement guidelines or age restrictions
coincide with the individual's choice, and therefore, do not affect it. On
the other hand, for the individual whose retirement decision is influenced by
social security retirement income, and who because of this retires early than
he would otherwise have done, savings will increase. The net result on private
s.ivings remain ambiguous; it is not clear a prior which group predominates,
and consequently whether savings will be increased or decreased for those who
have guaranteed retirement incomes.
Munnell's first study (1974a) reestimated a subsample of Cagan's
1959 data, from Consumer Reports subscribers. Correcting for factors such as
education, age, income, etc., and giving heavy weighting in the subsample to
individuals in their pre-retirement years, the study focussed on that group
who, being close to retirement, would be most responsive in their savings
behaviour. Quite contrary to Cagan's findings, Munnell's result were conso-
nant with those predicted by the traditional life cycle model. The net impact
on savings was negative, and there was clear evidence of a substitution and
an early retirement effect. Another study (1976) in which Munnell analyses
private pension coverage for men aged 45-59, comes to the same conclusion that
pension coverage discourages household savings in other forms. The study also
indicates,indirectly, somethling about the length of time over which folk plan,
since the substitution effect appears to be discernable only in the pre-retire-
ment age groups.
- 52 -
In addition to these cross-section studies, there are two time
series analyses (Munnell 1976, Feldstein 1974a) which should be mentioned.
These use aggregate rather than survey data, and estimate an aggregate
lifecycle consumption function, amended to include the effects of social
insurance and possible induced retirement.-! Both conclude that social
security has a depressive affect on private savings, although their esti-
mates of the decline in savings due to social security, differ.widely. Feldstein
estimates only the net effect of social security, while Munnell breaks the decline in
savings down into the retirement and benefit effects. Both studies measure
the impact of social security in a new way, using a "social security wealth"
series to measure benefits.- This is a constructed series which represents
(5SW1/ Munnell estimates: Retirement Saving 1+ 4Y + SSNW +
Staxes
4Y LF65 + o5UN
Feldstein's Equations: Personal Saving = < +9 Y+ 3 Y 1+ t 4 jgSN +
°( 5W 1+ d(6 UNo 7 RE
where Y x income, W, wealth, L765 - the labour force participation ofaged, UN, the rate of unemployment, and RE, retained earnings.
2 Social Security Wealth L __ _ )
Social Security Net Wealth =SSYN -[• , -
where N a the number of people in covered employment
the ratio of benefits to income in base period (assumed constant)Y: income in base period-
JO-
growc hof yeal per capita income (assumed constant) over working(j 4 ' perio dAdiscounted to the present.
tPL : Conditional probability that individual will live to age i,,'9 given that he has lived to age 20,
fi t X. :6 numerator insures that income will grow after retirement(benefits)are wage-indexed), and denominator discounts post-retirementQ ~)benefit3 back to age 65.
- 53 -
the present valtie of all social security benefits outstanding to the current
working and retired population - the total outstanding liabilities of the
system as a whole. Net wealth, the preseit value of benefits less the
taxes which remain to be paid until retirement is also used and tests whether
individuals view the social.security compulsory le, ties as a tax or whether
they see them as saving for retirement benefits.
The final study by Feldatein (1974c) estimates a life-cycle savings
function for a cross-section of 15 developed countries r/ showing the effects
of intercountry differences in social security provisions on retirement beha-
vior and on the savings rate. The study confirms Munnell's findings about
the importance of both the retirement and benefit effects. A one year de-
cline in the retirement age was shown to increase savings by about 1.97% and an
increase in the benefit level of 10% reduced savings by 3.2 %.
The Other Viewpoint
The life-cycle approach to savings, and the conclusions which
follow from it, with respect to the effects of social security on personal
savings (empirical evidence notwithstanding) could be criticized
(Pechman, Taussig & Aaron, 1968) on the grounds that it assumes too rational
behavior and requires too much perspicacity of the average saver. The
predicted savings behavior implied by life-cycle savings theories requires
that individuals base their savings on a correctly anticipated level of social
insurance benefits which may come to them only very far in the future.
A recent study (IBRD 1976) of the implications of social security
in Malaysia concludes that its effects on individual savings behavior is
minimal, precisely because individuals are unable to see through the "veil"
.B
1/ The equation is: S/Y + G + o3(` + q L)65M + AGED +iLEAGED.
where a. is the growth rate of national income, DP: the ratio of m.inors toadults 20-65 and LEAGED is life expectancy of those aged 65+&
-54-
of the payroll tax. Thus, rather than treating the compulsory levies as
"savings", they are seen by affiliates simply as tax. This observed
behaviour may be x; result of the newness of the system. Since the system
is still immature, and few have received benefits, it may indeed require
a leap of faith to recognize that benefits will be forthcoming, and even
more to anticipate them correctly. The "veil" explanation becomes less
plausible with the maturing of the system, when benefits are visible, and
approximately known to most. Nonetheless, this may take some time, with
the result that over a period, no substitution effect is discernable.
Another frequent agtgument to the effect that social security
will increase total savings is that the "grasshopper' antics" prevail: the
average individual is myopic, and fails to save in any systematic way for the
future. This is the vriew of Myers (1965) and Pechman (1968). Indeed, they
note, it is precisely for this reason - to protect such people from their
awn imprudence - that compulsory social insurance is required.-L/ While
this may be descriptive of some individuals, the failure to provide for own
retirement is probably typical behaviour only for those who quite simply
czi.tmot afford to, i.e., those who could not, rather than would not,provide
fcr their retirement.
Even if the "grasshopper antics" are co-on and where, therefore,
social security will generate forced saving where none existed before, the
sulbstitution effect of social security on savings may be mitigated. But
unless such behaviour predominates, it should not eliminate such substitution
altogether.
1/ Musgrave (Bowen et al, 1968) is far more cynical when he suggests thatcompulsory social security is rather a device to protect the wise andmore forsightful, who, in a h=anitarian system, would have to pay forsuch imprudence.
- 55 -
In sum, both from the theoretical and the empirical point of view,
the evidence regarding the effect of social insurance on personal savings
is inconclusive. The life cycle framework, which appears to provide a singu-
larly appropriate means of studying the effects of guaranteed retirement bene-
fits, suggests the net impact to be negative. However, as to the magnitude
of the effect, there is little consensus. Other studies, however, suggest
that- the direction may be positive, either because individuals see the social
security levies as a tax, or because future benefits are so far beyond their
planning horizon that their present savings behaviour remains usaffected.
Social Insurance and Government Savings
Another theoretical approach examines the effect of social
insurance on government saving. One study (Reviglio 1967) focusses on the
tax aspects of the system alone, testing the relationship between social
insurance taxes and total government revenues in a cross-section study of coun-
tries. The question is whether payroll taxes are an addition to 'normal'
government tax collections, or a substitute for some types of taxes, impairing
the government's ability to levy these taxes. The latter is what a taxable
capacity model would suggest. Reviglio's results suggest that payroll taxes
may be viewed differently from other taxes by taxpayers: his estimations show
that they provide a net addition to government revenues, and do not significantly
impair the government's tax levying ability. If this is indeed so, the conten-
tion that the chtoice of the payroll tax as a means of financing social security
benefits reduces public savings by reducing the potential size of government
surplus loses its force. If payroll taxes and other direct taxes are comple-
ments, there should be no negative impact on the level of government revenues.
56 -
la any case, the latter part of the argument is entirely separate from
the first, and need not follow at all. Higher government revenues may1/
imnly higher expenditures (Please, 1967) rather than a higher level of
government saving.
There is, however, a technical sense, as contrasted with
the political one, in which payroll taxes may reduce government revenues.
This is simply that the deductibility of employer contributions reduces the net
revenues from the corporate income tax and that this deficiency may not be
i elsewhere. Nonetheless, in either case, political or technical,
there is no evidence that the government's marginal propensity to save is
any greater than the private propensity (Morss, 1968) and that higher tax
revenues would have implied higher public sector savings.
All of the above assumes a strictly contributory system of social
insurance in which the government's contribution to the system, if any, is
qua employer only. Once the government be.gins to subsidize the social
insurance program, the story changes. Deficit financed subsidies to the
system represent government dissaving. To evaluate the net savings mobilized
by the social security system, it is the cash surplus net of any public sub-sidies which is of interest,
Does Social Security Affect Business Savings?
If social security were to affect business profits, it would do sovia the increased labour costs which the firm incurs if it.is unable to shift
1/ Please: "Savings Trough Taxation, Mirage or Reality?" Finance andDevelopment, 1967, pp.1-10.
- 57 -
the payroll tax. The theoretical arguments regarding shifting, whether
neoclassical, partial or general equilibrium, with or without growth
all maintain that the employer portion of the tax falls squarely on the
worker, either through reduced wages or through forward shifting onto
prices. As Milton Friedman notes, "The total tax for social security
includes what is euphemistically called a "contribution of the employer".
This is mislabelling. It is no contribution by the employer, it is a
compulsory tax, and it is not paid by the employer; it is, in effect, paid2/
by the wage earner ... the form, the name, does not change the substance."
Nlonetheless, business interviews continue to bring to light the contrary
view that the payroll tax is a costly imposition and a prime consideration
in hiring policies.3/
If the payroll tax cannot be shifted, business profits will be
affected. How this in turn would affect the ratio of dividends to retained
earnings,-business savings, is another unknown. Though the shifting question
1/ See Friedman (1965); Brittain, Pechman et al; Harberger and Feldstein(1971), respectively.
2/ "Transfer Payments and the Social Security System" Conference BoardRecord, Vol. 2 (Sept. 1965), p. 8 .
3/ Samuelson's "non-substitution theorem"' would deny that such substitutioncould be induced, because a payroll tax cannot raise tfe price of labourrelative to capital. Labour makes machines, and an increase in theprice of labour will in the long-run, increase the price of machines.In a small, open economy, however, which imports most of its capitalgoods, this will not be so. The problem of induced cap.ital intensitymay, therefore, be much more acute in LDCs than in developed countries.
-58 -
alone has been the subject of many studies, no empirical work has been
carried out on the issue of social insurance and business saving. In the
studies of national capital accumulation mentioned earlier - those of
Feldstein and Munnell - it has always been assumed that there is no effect,
in fact, they have also assumed that there has been no effect on government
savings..
Section III
Resource Allocation
An Analysis of Investment and Benefit Policies a
Factors leading to the Decapitalization of the Chilean Social Security Fund.
As explained earlier, even if there is a decline in discretionary
household savings, government savings or corporate savings, there is no need
f or total savings also to decline, provided the loss is made up by the
'savings' of the social secuirit-y institutions, that is, if the cash surpluses
of the social insurance system. exceed this decline. Indeed,since the decline in
personal savings is likely to be less than one for one because of the of f-
setting induced retirement effect and since the decline iii government saying
is unsure- in a fully funded system, total savings are likely to increase.
Thus, in the development literature, social security systems are often seen
as a means of mobilizing savings for development: funded schemes have,
in many countries, b'een designed with savings explicitly in mind.
The Chilean system, like most social securit-y programs, was
conceived originally as a fully capitalized fund. In the early Latin American systems
it was generally the private insurance analogy which led to this choice. In the
later Systems the savings potential was more often explicitly recognized
and provided the basis for the capitalization decision. Experience with
capitalization has not been an unqualified success. The past half century of
experience with social security has -be,6 many capitalized'systems succumb, dra-
wing down their trust fund to pay out current benefits. The United States?
system ,for example, designed and introduced in 1935 as a fully funded
system; had degenerated w• ':hin a decade and a half to its current pay-as-you-go
1/ Unless the system receives deficit financed subsidies.
-60-
status. The breakdown was due in large part to the decision to extend
blanket coverage to early affiliates due to retire shortly after the
system was introduced, but who had not paid in full complement of contri-
butions. The extension of coverage to spouses and the introduction of
survivors' pensions also contributed to the decapitalization of the
system. -
In Chile, pressures on the funds' reserves came from two
sides3 the clamour for ambitious benefits and poor financial management
of the funds' surpluses together caused the breakdown of the system.
While the inflationary environment made investment of the reserves that
were much more difficult, it is generally conceded that, at least until
the late 1960's, most of the losses-were self-inflicted; inflation was not
the sole cause of the financial losses suffered by the institutions.
There is a school of thought which suggests that the change-over
from capitalization to pay-as-you-go is an .inevitable part of the evolution
of social insurance schemes. These, in their early stages are frequently
small and excluvistic, covering initially only civil service, the armed
forces, banking, maritime, railway and public utilities, then urban manu-
facturing workers, and only much, much later, if ever, the rural sector and
almost never independent workers. Private insurance principles are difficult
to apply4 the latter worker groups. Their low wages make it difficult to
1/ The most recent of benefits without actuarial foundation is one (January1978) which authorizes benefits for divorcees of a 10 vear marriage,thereby permitting payments to multiple ex-spouses on one employee'saccount. (The duration of marriage for divorcee benefits was reducedfrom 20+ years.)
- - - ---
- 61 -
demand the contributory rates which would be required actuariaily to cover
them, and the absence of stable employment makes other affiliation
requirements unfeasible. Nonetheless, it is likely that a government con-
cerned with income distribution arnd social equality will move at some
point to extend social insurance coverage to these marginal groups. It
is at this point that financial tensions frequently arise. Social goals
and financial autonomy are not usually compatible.
Aaron (1967) 1 notes that the age of a system is amongst the primary
determinants of the level of social security expenditures. Older systems
such as those of Germany (1889) and the United Kingdom (1908) and Western
Europe in generall/tend to be broad and deep in coverage. And expensive as
well: virtually, the entire population is eligible for benefits and the
programs have expanded far beyond the old-age insurance with which they
were initiated. Wolfe (1967)4 notes a similar development in Latin America.
In those countries in which social security is fairly new,4/ the tendency has
been to increase the depth - the range of benefits - of the programs. The
geographical extension of coverage on the other hand, has been restricted,
largely because of the expense which it inevitably entails. These countries
1/ In 0. Eckstein, ed., Studies in the Economies of Income Maintenance.Brookings Institution. 1967.
2/ Austria (1906), France (1910), Luxemburg (1911), Sweden (1913),Netherlands (1913), Italy (1919).
3/ In E. Kassalow, ed., The Role of Social Security in Economic DevelopmentHEW 1967.
4/ Mexico (1942), Paraguay (1943), Bolivia (1956), JamAica (1965), Venezuela(1966), Colombia (1966).
- 62 -
form the basis for Wolfe's twofold grouping of Latin American social insurance
schemes: those whose schemes are largely without financial worries, but which
face a "crisis of exclusion", and those older program facing a "crisis of
inclusion": wide and deep coverage and its concomittant financial worries.
The evolution of a system and the extension of coverage to include
society's "poor risks" is one which undeniably implies additional expense.
The decision to extend coverage to groups unable to pay their own "risk
premia"5 is simply not compatible with adherence to strict insurance principles
and actuarial funding. These become increasingly difficult to maintain as
income redistribution succeeds income maintenance as the object of social
security. Frequently, therefore, this conceptual evolution is also accompanied
by a gradual switch from funding to pay-as-you-go financing since payroll taxes
for continued capitalization are simply too high and thence to general revenue
financing. The switch. of course. also Duts an end to the system's savingsmobilizati on.
in Chile, the decapitalizgtion of the social insurance reserves
followed this evolutionary route. The switch was due to a combination of the
singular social process and the persistent inflation the economy experienced
since the 1930's. "Social imperatives" led to the introduction of many new
benefit regimes which were costly from an actuarial point of view; social
imperatives also affected the funds' portfolio choice. Its 50 year history
of inflation notwithstanding, Chile look to indexing only very recently and
even rather reluctantly in the face of stringent sanctions qgainst "usury"
(which included the indexation of debt) in the Napoleonic civil code. Infla-
tion thus eroded the real value of the reserve fund which in an actuarial
system would have been drawn on to payout benefits and reduced the funds'
capital income which, in an actuarial system, would have supplemented payroll
levies in a systematic way.
- 63
The private institutions and the smaller semi-fiscal funds
(such as the municipal employees' and bankers' funds) generally fared better
than the large public institutions. The latter, as public corporations-
were subject to norms laid down by the Finance Ministry for almost all
2/their activit.ies- , and as public corporations, they were also inevitably .used as
an arm of government social policy. The others, on the other hand, so small
that they made up no effective constituency, were not subject to government
intervention or control. As a result, they had far greater administrative
freedom and agility, and were managed in a more business-like manner.
The differences between the two groups of institutions go much
deeper than just their financial freedom and thus the private funds cannot be
used as a "control group" against which the performance of the semi-fiscal
institutions can be measured. Firstly, 'initial conditions' differed. The
withdrawal of the high income groups and specialized employees from the gene-
ral groupings of employees into their own "optimal clubs" jeopardized the
financial solvency,of the original institutions. Secondly, the specialized
funds' income derived, in addition to the payroll levies, from receipts of
special earmarked taxes which were fairly inflation-proof.-3- Their homoge-
neous membership moreover, insured that no groups of affiliates implied a
financial drag on the institution. In short, they began as financially
sounder institutions, and while comparisons can be made, one is really dealing
1/ Corporaciones de Derecho Publico.
2/ The Ley de la Administracion Publica regulates norms for: requisitionsand purchases, personnel, capital market activity, foreign exchangedealings, foreign borrowing, transport and finance.
3/ These include taxes on bank accounts, betting receipts, newspapers andperiodicals, theatre and movie tickets, sea-freight tariffs, etc.
.~~~ -i -W t- - - -; -; - - -
64
with two very different types of institution, subject to very dissimilar
constraints. It is only on the side of financial management and investment
policy where conuparisons become fruitful: on all other aspects, their
purposes are simply too divergent: the private funds were never agents of so-
cial. policy, which is always a loosing proposition.
"Social Imperatives" and Benefit Policies
Social security institutions in Chile, as elsewhere in Latin
America, have been considered primarily as instruments of social policy.
The emphasis has been on administration and provision of social services.
Little attention was ever devoted to examining the wider financial implica-
tions of many policies which the institutions pursued at the behest of the
government, nor was the financial potential of the system ever seriously
explored, Financial planning was regarded as a secondary; an accessory,
though unavoidable task. In short, there was a general feeling that govern-
ment should concern itself with providing benefits - to dwell on their finan-
cing smacked of reactionism, and the "private" mentality, and denied the
primacy of social concerns.
The development of increasingly socially oriented policies can be
traced in Chile through three periods. Social security has always had a
social orientation in Chile: its broad coverage, as early even as 1925,
attests to this. Nonetheless during the first 30 years of the system's operation
(1924-S2), it was run generally speaking, on insurance principles, with
income maintenance, not redistribution the primary object. 1952 marked a
watershed for putblic policy with respect to social security. Attention focussed
on providing for the poorer groups in the labour force and their families, and
- 65-
simple programs of income maintenance were deemed insufficient. Because
attending to the needs of society's "poor risks" could not be reconciled
with private insurance principles, their low incomes and employment habits
making this impossible, these principles were implicitly dropped when the
benefit programs were expanded. By 1952, the Chilean Congress had made the
definitive decision to emphasize the social rather than the insurance
aspects of social insurance, and it was a leap of some dimensions. While
there is no doubt that the decision to increase benefits and provide cover-
age to groups of workers usually outside the scope of social security made
these poorer groups much. better off, it is equally undeniable that the
1952 reforms made the breakdown of the earlier actuarially funded scheme
inevitabl.e.
The most important new benefit of this second period was the
minimum pension, introduced because of the observed low level of actuarial
pensions for many groups. Since pensions were a function of the level of
past contributions, which in turn, were a function of income, even if contri-
butory rates had been very high, it was inevitable that pensions would be
low because incomes of these groups were so low. A minimum pension, which
exceeded the actuarial pension was therefore needed to insure an acceptable
standard for all retiring workers.
The low level of actuarial pensions were, ironically, themselves
an indirect result of an earlier government policy. The ceilings on the
fraction of income subject to payroll taxes had been lowered at various times
to reduce the burden of this tax on poorer workers affiliated to the Caja de
Seguro Obligatorio. Since the payroll tax base was also the base salary on
66
which pensions were calculated, the very policy which sought to reduce the
payroll tax burden for these workers also limited the benefits.
The minimum pension reform completely changed the solvency of
many of the funds, since the program was introduced with no explicit financing
arrangements. It was left implicit that the difference between the actuarial
pension and the minimum should be charged against the trust-fund, supplemented
if necessary, by subsidy from the government.
A poor interpretation of the minimum pension law dealt the
Servicic de Seguro Social an especially heavy blow. In provisions dating
back to 1925, affiliates had always been given the option of withdrawing their
acquired entitlements as a pension, or in a lump-sum. Fewer than 5,000, out
of some 40,000 retired members chose to draw a pension, the majority opting
for the lump sum entitlement. Later, this same group was held to qualify
for a minimum pension, on the grounds that while they had fulfilled all the
requirements with respect to age and number of contributions, they were not
receiving any regularly paid pensions - the Seguro Obligatorio, incredibly,
paid out twice.
Succeeding low incomes, the other characteristic of the labour
force in many IfCs, including Chile, is the informal and discontinuous nature
of its employment. Thirty years of continuous,salaried employment is likely
to be the exception rather than the norm. Recognizing thi*, social pressures
once again led to the rejection of the so-called "private mentality", which
would suspend benefits for those who failed to comply with the requirements
or ehe funds, and would have left them with few, or no entitlements. 1956
thus saw the introduction of "continuous protection", a method whereby those
whose employment history was spotty, could fill in the gaps in their contri-
butions.
1/ Servicio de Segurn SnrbiAl 14 in f,ie- -
- 67 -
This provision gained some notoriety, not because of its intent
but thanks to the financial sleight of hand which was devised to finance
it. Workers, who at retirement found themselves ineligible for pensions,
could apply to the social security institutions for a loan to make up the
missed contributions and thereby secure eligibility. The fund would then
grant the pension, and the recipient was to service the loan out of the
pension itself. Effectively, pension entitlements were conjured out of
thin air, although to the unschooled eye, the scheme appeared legitimate
exiough. Interest rates and maturities on these loans, as on all financial
dealings of the institutions were llid down in 'leyes organicas' legislated
by Congress. The debt service ratio could not exceed 20% of the pension.
In the logic of the times, this did not limit the principal of these loans
to an amount which generated repayments less than the 20% ceiling, but
implied simply that the debt service charged to the pensioner could not
exceed 20% of his pension, with remainder was charged to the institution.
The continuous protection innovation dealth another heavy blow
to the financial position of the system, especially to the Servicio de
Seguro Social, whose affiliates were most likely to come up against eligi-
bility requirements.
Amendments to the 1952 reforms vera continuous throughout the
following decade. In 1961, pensions were made adjustable for inflation,
and early retirement, at 55 instead of 60, was introduced for women.
Assistance pensions were another major innovation. These were granted
to the 'aged and indigent' who had not fulfilled any of the eligibility
requirements for even the minimum pension. Shortly thereafter, early
retirement was also granted for those engaged in heavy labour, and the
minimum levels of orphans' and widows'survivors' pensions were raised. All
- 68 -
of these changes were costly from an actuarial point of view; only for
the inflation adjustment anid for the assistance pensions was financing
ever explicitly provided.
New groups of workers were incorporated into the system throughout
the period as well. Fishermen, taxi drivers, newsboys, hairdressers, all
obtained coverage. (Agricultural workers and domestic servants had long
since been covered.) Financ:Lng for these groups was quite explicit, but they
were not, it Is now conceded, self-supporting.
Those benefits which could not be financed on a current basis weregenerally charged against the trust fund-or covered M'y the government, which,
although it had no specific obligations, undertook the general obligation tosupport the institutions when they were unable to pay out benefits laid down inthe organic laws. Tables 15 and 16 show the differences between the level ofcash surplus the system generated when this public subsidy is included and
when it is netted out. By reducing the size of the cash surpluses, the generousbut inadequately financed benefit policy destroyed the actuarial basis of thesystem and made full funding quite impossible.
- 69 -
TABLE 15
Gross and Net Cash Surpluses of the Chilean Social Security System -
1946-75
1q9A PricesAnnual Cash Surplus Government Subsidy Net Cash Surplus
(Thousand Pesos) (Thousand Pesos) (Thousand Pesos)
1946 30 4.1 25.9
1947 27 3.8 23.Z
1948 29 5.0 2.4
1949 31 7.8 23.2
1950 33..0 12.7 20.3
1951 39.0 14.0 25.0
1952 41.0
1953 61.0
1954 54.0
1955 52.0 -
1956 32.0 11.7 20.3
1957 31.0 14.2 17.8
1958 41.0
1959 5X.0 17.7 32.3
1960 48.0 19.8 28.2
1961. 44.0 22.2 21.8
1962 45.0 24.3 20.7
1963
1964 42.0 12.2 29.8
1965 21.0 9.5 11.5
1966 28.0 29.1 -1.1
1967 25.0 22.4 2.6
1971 82.0 26.7 , -185
1972 46.0 11.1 -65
1975 48.0 74 -24
Source: 1946-67, Finanza4, Bancos Y Cajas Sociales. 1971-75, The Cost of Social Securit
1/ Because of the changing classifications from year to year of what constitutes
the government contribution 'qua employee' opposed to its direct plus interestsubsidies to the system, these figutes are not exact figures.
- 70 -
Table 16
Net and Gross Cash Surpluses as a Fraction of
Social Security Receipts
1946-75Gov't. subsidy
Net Cash Surplus as Gross Surplus as as % of Gross% of Soc.Sec. Receipts % of Soc. Sec. Receipts Cash Surplus
1946 29.2% 34.0 13.61947 26.5 30.0 14.01948 24.4 30.0 17.21949 22.2 31.0 25.21950 19.3 32.0 38.51951 21.8 34.0 35.81952 - 33.0 -1953 - 40.01954 - 38.01955 - 38.01956 14.4 38.0 36.61957 10.2 28.0 45.81958 - 29.0 -1959 16.3 25.0 35.41960 12.2 22.0 41.21961 9.6 19.0 50.41962 8.3 18.0 54.01963 -
1964 16.0 29.01965 3.7 6.8 45.21966 -0.4 7.2 -103.91967 0.7 5.6 89.6
1971 -25.0 9.0 -325.01972 -22.0 14.0 -241.0
1975 -0.01 20.8 -154.0
- figures not available.
Summary
By 1952, the Chilean legislature had made a definite choice
to change the nature of the social insurance system. The decision was
made to benefit the many workers, who because of their low wages and em-
ployment opportunities,would ordinarily be disquialified under an actuarial
system run in accordance with strict insurance principles. The legislation
introduced in the course of the 1950s opened up the system to almost
all workers and awarded generous benefits to most. However the focus
of the reforms was on the. benefits side. Financial aspects of the new
programs were virtually neglected and those benefits which were introduced
with an explicit financing arrangement, these were frequently deficient.
Since the new programs once legislated, became part of the body of 'leyes or-
ganicas' governing the institutions, the entitlements they delineated
had, by law.,to be paid out by the institution, regardless of its financial
situation. To the affiliate, they beca"a. 'acquired rights' which had to be
honored. The cost of many of the reforms, especially the minimum pensions
and the early retirement was high, and it was all charged against the
reserve fund. Thus, by 1952, the eventual switch to a pay-as-you-go
system was made inevitable.
In short, 1952 brought about a definitive change from funding
to pay-as-you-go, the necessary response to the financial pressures
brought on by the new benefit programes.
- 72 -
Portfolio Choice and the Reserve Fund
There are three basic criteria for the investment of social
insurance surpluses. (1) Management may seek the highest return for the
necessary liquidity and acceptable risk levels. The profitability criterion
is the one used by private pension funds, who invest for a target rate of
return. (2) Surpluses may be invested in line with the perceived develop-.
ment goals of the country. In this case, investment of the cash surpluses
will be coordinated with, sometimes subordinated to national investment
priorities. This. policy may mean investment in favored sectors such as steel
and transport, or social investments such as housing, clinics and schools.
Such investment may be direct, or indirect, as when the funds invest in
government securities. (3) Finally, surpluses may be used in keeping with the
needs of the present generation of affiliates, since the funds are, in fact,
"their" funds, held in trust for them. Surpluses can be returned to the affi-
liates through personal loans,housing, or mortgages, social facilities, etc.
The type of portfolio depends in part on the extension of the
system and the kinds of risks with which it deals. Liquidity of investments
and good cash management are primary concerns when protection against short-
term riskf figures importantly in the system's coverage. For systems in which
pensions predominate, long-term securities are appropriate and liquidity be-
comes a secondary importance.
Because the magnitude of the social security reserve funds and the
potential resource allocation impact has made the investment of these surpluses
something of national interest in almost all countries, it is quite rare that
criterion (1)-the quasi-independent solution--be chosen. In Latin America.
only in Venezuela and Ecuador surpluses be
invested with consideration to the lucrativeness of the investmentW and
maintenance of real asset values. In Argentina, surpluses have been channelled
- u SSX > i7N ; *ae i mi C i'@ 4 >r 3 aS 1 ' i: B'6l.,>At;' ......... RtR4' -.Y..... >e>.fi-;...... .@;:. ... u *it.4<.Q:X:.X ......... Filaa.; >.ie2;:v:t.Sss.sos............ .> w.
- 73 -
through a speaval fund for investment in steel, transport and other
essential economic sectors. In Bolivia, Mexico and Ecuador, investment of
the funds .are directed towards hospital, clinics, loans and the like, with
the qualification that these earn a specified return. Investment in private
securities is allowed only when these are backed by adequate sinking funds
for the repayment of interest and principal.
The great importance of social security surpluses and their
potential impact on national investment and social welfare also made the
portfolio of the institutions something of national interest in Chile. Very
shortly after their founding, all Cajas' financial dealings became subject to
the governance of the legislative branch. A growing body of legal disposi-
tions came to control the investment of the cash surpluses, and the semi-
fiscal institutions ceased to have much say regarding the manner in which
their funds were invested. Moreover, once the investment program was drawn
up, it was revised by the Ministry of Finance to coordinate the national
investment programs.
The emphasis of .ze investment legislation, throughout the system's
history, has been social. In keeping with criterion (3),funds were to be used
for the benefit, directly or indirectly, of the institution's affiliates. The.
range of permissible investment initially included mortgage loans, personal
assistance loans, -rental property and other real estate, as well as government
securities. The involvement of Congress, however, went far beyond simply the
portfolio distribution, which was only one of the instruments through which
its social aims could pursued. Congress set the interest rates which could
be changed on each type of loan. Congress also decreed their maturities, and
amortization rates. Rent controls were also established in the buildings owned
74
by the Cajas for let to affiliates. In short, the social insurance reserves,
invested in line with criterion (3) provided a gamut of additional benefits
-- from loans to subsidized housing -- to the systems affiliates.
Specific policies regarding investment of the surpluses can be
grouped into 4 periods which mark a conceptual evolution regarding appropriate
investment policies. Table 15 indicates how the portfolio composition has changed as
a consequence of the policy choices which were made.
Throughout the initial period, from the establishment of the funds until
the late 1940's, safety of investment was a prime criterion. Government securi-
ties, and securities of public corporations, mortgage loans, savings deposits and
rental property and other income earnings real estate were the permissible cate-
gories. These 6 categories correspond to investment traditionally considered to
be risk free.
1952 saw the establishment of a much broader and more integral
system of social security, and also a conceptual change in ideas regarding
the investment of surpluses. The development of a national housing program
made it natural to channel them towards construction and acquisition of
houses, the Cajas extended mortgage loans and became involved in construction
programs of their own. Purchase of the securities of private corporations
was also permitted ras long as they were highly rated). Finally, the prac-
tice of granting assistance loans (which were introduced in 1930) was insti-
tutionalized, and, these quickly became an important categor~y of asset to tie
institutions, and an important new source of benefits to the affiliates. In
short, the 1952 laws greatly broadened the scope of the permissible portfolio,
embracing private securities and opening the way for the newest of benefits,
the use of the systems' funds for its own affiliates. The primacy of the
social goals becomes quite evident in this period.
- 75 -
Table 17
Percentagc Distribution of Assets of. Chiilean'Social Security Institutions
1936 -74
Equipment,Cash Real Furniture, Gov't Personal dDeposits Estate Inventory Equitv Bonds Mortgages Loans
1937 5.0% 1lLOZ 16.0 30.01938 3.0 18.0 20.0 47.01939 1.0 14.0 14.0 48.01940 2.0 20.0 17.0 67.01941 3.0 17.0 12.0 52.01942 3.0 17.0 12.0 56.01943 - -
1944 4.0 17.0 10.0 43.01945 7.0 17.0 10.0 42.01946 4.0 19.0 3.0 9.0 39.0 14.01947 6.0 19.0 1.0 9.0 30.0 20.01948 8.0 19.0 2.0 7.0 27.0 22.01949 7.0 19.0 1.0 7.0 26.0 14.01950 4.0 20.0 2.0 5.0 25.0 13.01951 3.0 21.0 1.0 4.0 26.0 15.01952 3.0 21.0 2.0 3.0 27.0 15.01953 8.0 17.0 2.0 2.0 22.0 17.01954 16.0 15.0 3.0 5.0 19.0 15.01955 9.0 19.0 4.0 4.0 16.0 15.01956 4.0 26.0 3.0 3.0 12.0 13.01957 5.0 28.0 3.0 2.0 13.0 15.01958 -
-
1959 5.0 30.0 3.0 1.0 18.0 9.01960 6.0 37.0 4.0 1.0 17.0 14.01961 4.0 23.0 3.0 16.0 13.01962 8.0 19.0 4.0 16.0 17.01963 14.0 13.0 1.0 3.0 16.0 16.01964 19.0 10.0 1.0 2.0 . 18.0 14.01965 16.0 11.0 1.0 2.0 17.0 14.01966 15.0 9.0 1.0 . 1.0 13.0 12.01967 10.0 8.0 1.0 1.0 10.0 10.0
1974 53.0 15.0 27.0
Source: Superintendency of Social Security.
76 -
Aft'er1952, the range of permissible investments continued . --
to grow, but the changes were generally marginal and affectied only small
groups. (Thus, loans could be authorized for additions and improvements
to existing houses, rather than solely for construction of new units,
and a certain proportion of the loans was earmarked from affiliates with large
families and for the poorer members.) In the 1960 s the social emphasis
took on a slightly new slant, as a series of one-time loans was legislated,
such as loans to residents of a drought stricken area, and earthquake victims
1959 marked a drastic change in both the financial administration
of the portfolio as well as in the structure of the portfolio itjelf. The
intent of the new law, the DFL #2 was to emphasize the financial aspects of
the investments, and the importance of protecting real asset values, without
prejudicing any of the social legislation of previous reforms. Loans and
mortgages thus became fully indexed to the inflation rate. The housing prog-
ram of the various institutions was consolidated, and all surpluses not des-
tined for assistance loans and other direct benefits to affiliates were thence-
forth turned over to the state housing corporation, CORVI. Housing became the
exclusive preview of this institution, a reform which was intended to stream-
line the funds!own.involvement and reduce their administrative costs.
11. 1974 marked the final policy change. The primacy of social goals
was effectively denied,CORVI transfers were suspendea, and government securi-
ties became the only permissible asset. The list is again being gradually
broadened to include private securities, but the financial aspects of invest-
ment alternatives are ever stressed: personal loans and mortgages are no longer
granted. The model which the government hopes to follow is one in which the
77 -
social securirty- sector gives impetus to the fledgeling capital market
provided by providing new source of industrial financing and by encouraging
previously closely held corporations to go public.
A "Social Imperatives" Tnvestment Strategy: The Consequences
The social policy pursued by Congress through the invest-
ment strategy of the Cajas was not without cost. Disregard for sound
financial management devastated the funds' asset position just as neglect
of the benefit policies'financial aspects had jeopardized it.Ironically,
social aspects of investment were accentuated as the rate of inflation
accelerated. Safeguards against inflation losses were introduced only
after great hesitation; since they inevitably implied tougher loan terms to
the funds' affiliates, they were politically unpopular with the congressional
constituency.
That the funds'financial constraints would imply a concomittant
financial sacrifice appears to have been ignored - at 1east the tradeoffs
were never explicitly recognized, though they nLave been, even as early
as the 1930's.
Even the experience with real estate, which in 1925 made up the bulk
of the funds assets, was not successful. The problems were two-fold. Some
were due to the great diversity in the types of holdings which the funds acquired
and the funds' generalized lack of .administrative experience. Secondly, the
norms governing all aspects of the funds' financial dealings were legislated in,
and presumably for a period of relative price stability. Inflatiton was simply
not a parameter at the time. Since these norms were laid down in organic laws,
they were entirely inflexible and could be amended only with great difficulty.
- 78 -
The range of properties which the funds chose to own is quite
astonishing. It included rental properties, agricultural 'fundos', casinos,
theatres and cinemas, resort complexes, office buildings, to name a few.
This diversity, both of type and location made administration difficult.
Moreover, good administrators were hard to find, since their remuneration was
limited by the ubiquitous and pernicious bureaucratic law to the salary of
someone of "equivalent" rank in the social security administration. The
farms and commercial buildings, both purchased for commercial exploitations
were seldom well administered and generated little income. Once again, there
was confusion between social goals and financial principles. Controlled rents
were so low that they did not cover building maintenance expenses, much less
amortization and interest costs, or an adequate rate of return for the ins-
titution. Mortgage loans, the other mainstay of the portfolio, making up
some 30-40% of the funds' assets in the first period were granted on easy
terms. By law, they had 30 year maturities and carried a 6% interest charge.
Debt service limits were also set, limiting repayment of mortgage loans to
20% of income. As with the provisions for'continuous protection', the
principal loaned was not generally constrained - only the debt service
The losses to the system which occurred as a result of these policies have
never been directly calculated. A study of the investment policy of a single
institution, EMPART, concludes that for this Caja alone, on average, less
than 14% of the principal plus interest due was recouped or; mortgage loans
extended during the 1925-52 period. No attempt was made to estimate the
cost of the rent controls nor to impute losses directly to poor administra-
tion. It is known, however, that when the institutions sold off their commer-
cial property and fundos they did not, in general, fare well.
- 79 -
By the 1950 's the economic consequences of the financial guidelines --
and administrative regulations had become quite clear. The funds' capital
income which had been expected to supplement payroll tax contributions did
not do so to any significant degree, and the asset position of the funds wasalso precarious. In 1952, an-attempt was maae to reduce the major source of
losses -- the long amortization period of mortgage loans. The repayment period
was shortened to 16 years, although for social reasons, the interest rate was
left at 6%. The simple modification of the amortization period reduced the
erosion in the real value of the loan principal due to inflation, but still
there no thought given to adjusting the interest rate. The percentage ofprinciple and interest dtne or which was recouped on loans of this neriod
(1952-59) was 39%. With respect to personal assistance loans, the
rate during this period was on the order of 20-30%. Much of these
losses were due to write-offs of the loans. Frequently, collection costs
exceeded the value of the installments,and rather than collect them, these
amounts were simply written off as bad debts. Since mortgage and assistance
loans together made up some 35-40% of the portfolio, the losses the interest
rate policy implied were substantial.
It was not until 1959 that any real attempts were made to deal with
the seriousness of the situation. As Table 18 shows, the value of the
assets of the social insurance system, in real terms had declined since 1946,
in spite of the record growth in the surpluses the system was generating duringthis period (Table 16 ). The DFL #2 was one of the many re'forms introduced
in the aftermath of the 1959 Klein-Saks mission to Chile. Loans made under
DFL #2 were fully indexed; the interest rate (4%) thus represented, for the
first time in 35 years, a real interest charge. To soften the blow of the
stringency of the new financial conditions, the terms of the loans were
again lengthened to 30 years. Nonetheless, even with the DFL #2, it was
- 80 -
Table 18
Social Security Wealth
Total AssetsConstant
(1958 - 100 )Prices
1937 20.0
1938 165.0
1939 188.0
1940 148.0
1941 172.0
1942 151.0
1943 -
1944 191.6
1945 199.2
1946 224.9
1947 200.0
1948 208.0
1949 220.8
1950 233.8
1951 240.7
195227G
1953
1954 231.0
1955 194.0
1956 182.0
1957 205.0
1958 -
1959 207.0
1960 245.0
1962-. 295,t0
1962 317.0
1963 275.0
1964 291e0
1965 314.0
1966 406.0
1967 514.0
1974 351.0
Source: Supern.tendency of Social Securi,y.
Table 19
Annual Cash Surpluse l/ Chilean Social Security System
Annual CashSurplus in Annual CashConstant 1958 Surplus as aPrices % of Receipts
1935 -1936 9.0 30.01937 6.0 32.01938 10,5 37.01939 b.0 28.01940 10.9 26.01941 13.3 31.01942 9.7 27.01943 -1944 13.7 34.01945 14.0 29.0.1946 2/ 30.0 34.01947 27.0 30.01948 29.0 30.01949 31.0 31.01950 33.0 32.01951 39.0 34.01952 41.0 33.01953 61.0 40.01954 54.0 38.01955 52.0 38.01956 32.0 38.01957 31.0 28.01958 41.0 29.01959 50.0 25.01960 48.0 22.01961 44.0 19.01962 45.0 18.01963 - -1964 42.0 16.01965 21.0 6.01966 28.0 7.01967 25.0 5.0
1971 81.0 9.01972 46.0 14.0
1975 48.0 20. G
1/ Includes government subsidy.
2/ Years 1935-45 and 1946-75 are not strictly comparable, as the latterperiod includes some institutions not included in the earlier one.
- 82 -
impossible to get away entirely from the social imperatives. The loans were
indexed in accordance with changes in the consumer price index or the index
of wages and salaries, which ever was the lower. Because of this slightly
less than the total, approximately 98% of real value of the DFL #2 loans was
recouped.
Other laws, however, continued to jeopardized the funds'
financial return, even after 1959. These were primarily the "leyes mo-
ratorias" introduced by the Allessandri administration and continued
under that of Freil/, ;1hich allowed debtors to suspend repayments during
validated periods of personal hardship.
The other innovation of the DFL #2 was the housing program.
From 1959 on, all of the surpluses from the semi-fiscal institutions went to
CORVI,f the national housing agency. The plan was that CORVI should take
over all of the institutions construction programs, turning over completed
units to the institutions for sale to affiliates and otherL', The portfolio
of the institutions became, thereafter, essentially, only assistance and
mortgage loans. The functioning of the program and the' of the
funds' transfers to CORVI was once again impaired by the absence of any
inflation safeguards. The biggest problem was cost-overruns due to the
rising cost of construction and materials. However, there were also
unaccountable delays in construction, which in turn delayed the transfer
of completed units to the social insurance institutions. The funds thus lost
twice: cost overruns implied that they got fewer houses than they had paid
for, delay in completion put off the date at which the institution could sell
the unit and begin to collect income from it. The estimated erosion in real
values of the CORVI transfers is about 57%, i.e., the funds it ibevalue of housing units only 43% of the monies they transferred to CORVI.
1/ 1958-64, 1964-70, respectively.2/ Corporacioii de Vivienda.
- 83 -
To sum up, the implications of DFL #2 for the funds' asset position
is uncertain. Unquestionably, it put all end to the major abuses of the
old loan system. On the other hand, the housing program itself generated
losses. The combined effect is difficult to determine; loans constituted
a larger fraction of their assets than did CORVI transfers and so it is likely
that the net effect was positive. Table 15b shows that their asset position
did indeed improve after 1959 - although this is the result of interaction
of factors other than just the two mentioned above.
The final period from 1974 to the present brings back the criterion
of profitability and positive real returns to social security. CORVI trans-
fers were halted, the portfolio limited to indexed
government bonds, which currently pay a real interest rate of 5 percent, and
have a 6 year maturity. While this guarantees a return for the Cajas, the
government would like to see the gradual broadening of the portfolio, to
avoid incurring excessive interest liabilities. The monetary authorities
are also anxious to avoid a repetition of a 1974 policy action in which the
surpluses of the social security institutions became an instrument of monetary
policy - the cash surpluses of that year were transferred to the government
and to reduce the money supply. This implied a tremendous volume of
completely unbacked new liabilities for Treasury - liabilities which could.
only be honoured via the printing presses, making future monetary policy more
difficult, albeit assuaging current problems. Diversification of the port-
folio into private securities lessens the possibility that this could occur
anew.
- 84'
Since the 1973 change of governments, the pendulum has gone
fu'l swing from the primacy of social goals to the primacy of financial
soundness. If the portfolio diversification goes as planned, the
system will be operating as does a private pension fund . It will be
actuarially sound and will no longer receive government transfers.
The Non-Fiscal Institutions
The non-fiscal institutions have never been subject to many
of the constraints discussed above which crippled the large semi-fiscal
funds. Though by law they are obliged to provide the same range of bene-
fits - pensions, family allowances, health care and workmens' compensation,
they are quite free to operate outside of the rigid operitional directives
establ.ished in the Law of Public Administration. Freedom to pursue their
own investment policy has perhaps their greatest advantage.
Thq composition of portfolios of the two groups shows some
striking dia-egrgn£e. Tabe show. that on average, throughout the period
covered. the ptivate funds held a larger prqportion of their assets in equity
than did the others, and as inflarion accelerated, less and less was held in
cash and deposits. The Table is unfortunate,ly only impressionistic since
balance sheet inforation is not complete for all years. 1While the balance
sheet figures are not available aor 1974, the Superintendency estimates tha
the trend has been upheld.
Table 20
Chilean Social Security Systemn
Percentage Distribution of Assets, Selected Funds
1935 - 1974
CASH AND REAL EQUITY 6 GOV'T BONDS PERSONALDEPOSITS ESTATE Equlty Bonds Equity Bonds HMORTAGES LOANS OTHERPubi./ Priv. P riv. Publ. / Priv. jrhb. Priv.1935 SSS / Hochschlild
CANAEHPU / Cervecerias 7 -- 4 -- 35 -- -- 32 -- 10 --EMPART / Banco Central 1 - 11 -- 30 -- -- 51 -1940 SSS Hockschild 6 -- 27 - 4 . 21 -- -- 2 -- 13 --CANAEMPU / CerJcerlas 31 -- 13 -- 14 -- -- 46 -- 11 --EMPART Banco Central 1 -- 11 -- 6 -- -- 70 --1945 SSS Hochschild 5 37 -- 27 -- -- 3CANAEKPU Cervecarias 9 -- 21 -- 13 -- -- 45EXPART Banco Central 3 -- 8 3 S O52
001950 SSS llochschild 2 11 28 4 11 16 42 3 24 3 18 U'CANAEHPU / Cervecerias 7 3 30 - 10 2 26 21 54 14 14 1EMPART / Banco Central - 7 12 1 1 4 3 29 78 14 7
1955 SSS Hochachild 26 31 9 - 8 4 21 - 4 26 - '23CANAEMPU Cervecerias 3 15 21 - - 9 4 2 16 55 25 11EMPART Banco Central a8 2 - - 5 5 - 27 74 16 131960 SSS Hochschild 11 17 48 - 10 1 20 - 1 39 2 21CANAEHPU/ Cervecerias 3 6 11 - - 2 7 - 23 55 45 13EKPART Banco Central 4 5 44 56 - - - - 19 10 18 51965 SSS llochachild 28 9 8 - 7 12 16 63 - 15CANAEMPU ,Cervecerias 3 - - - 12 26 34 46 70EHPART / Banco Central 4 16 12 39 15 11 10 6 -
15
I274 SSS lHochscihild 62 10* 17 17CANAEMPU Cervecerias 61 10 7 30 1EMPART Banco Central 52 10 16 30
-- : not available.
no significant Investments In this category.
estimated by Superintendencta.
86-
Another aspect of their investment policy cannot be discerned
from the portfolio composition. While the table shows the investments in
real estate to be heavy, and loans and mortgages as dominant in their port-
folio as in the portfolio of the public funds, it obscures the fact that
these were not subject to the same directives as the public institutions.
There were no unions to satisfy, no interest ceilings to suffer, no terms
to adhere to. Repayment moratoria were not institutionalized, and real es-
tate was privately managed for the private good. This administrative freedom
gave these funds an immense advantage. Their cash management was generally
excellent - unlike the public institutions who could not make shott-term
placements in 'approved' categories of assets, and consequently had no al-
ternative but to maintain large cash holdings and current deposits. One
firm's fund, Gildemeister y Cia, even relent to its own employer, reinvesting
the surpluses in the firm itself. While this may not be wise on portfolio
diversification grounds, the return was generally excellent.
It is extremely difficult'to evaluate the portfolio performance
of the funds, other than qualitatively. The size of a fund's surplus and
changes in its asset position depend on many factors, - the maturity of the
system, the changes in tax rates, etc.-/ Among these factors is also the
change in asset values relative to changes in the price level. There are
immense complications in tracing these effects even for a small fund alone:
to separate the factors for the system as a whole is quite,impossible. Thus,
any evidence suggesting that the asset position of the non-fiscal institu-
tions was more immune to inflation than that of the ones within the budgetary
public sector will necessarily have to be Circumstancial.
1/ See page 39 for discusaion.
- 87 -
Th eindex of portfolio values presented in Table 18 shows --
that throughout the period the private funds have fared much better than
their public counterparts. The value of the private funds' portfolio
increased by about 900%, that of the others increased by just over one
half.
Table 21
A-verage Real Portfolio Value of Private and Public Social Security Funds
Selected Institutions, 1950 100
Private Funds Semi-Fiscal Funds
1950 100 100
1955 304 93
1960 441 114
1965 72.4 150
1977 904. 157
Source: Mission estimates.
While some of the difference is indeed due to differing patterns of retirement
amongst affiliates and the differing burden of non-actuarial-minimum benefit
obligations, it is unlikely that the entire differential can be attributed to
these factors. Much-of the explanation clearly lies in the principles of in-
vestment management followed by the two sets of institutions.
-88-
Because of their superior investment performance, the private
funds are, at present, fairly sound from a financial point of view. Their
benefits are consistently higher than those of the semi-fiscal institutions,
even though for some of them, payroll tax rates have not been increased
since 1959. In sum, while necessarily impressionistic, the evidence
suggests that inflation was not the sole cause of the decapitalization of
the trust funds:a somewhat more inflation-proof policy could have been-
followed.
Conclusion
The history of the investment policy of the social insurance
institutions highlights the antagonism between the social and political
demands for uses of the funds' resources and financial imperatives.for fis-
cal soundness.
The decision to follow the third investment criterion - to use the
surpluses to benefit those for whom they are held in trust - is an entirely
legitimate choice. However, the Chilean authorities, in opting for the
social criterion neglected to take into consideration some basic economic
facts and the inflationary condition of the economy, and to design the policy
accordingly. It seemed impossible to strike a balance between social goals
and financial principles. Indexing of debt, even when inflation rates
reached 50Z a year, was seen as usurious, - repayment periods of less than
30 years seen as unconscionably harsh, - market-level rents at odds with the
very principle of equity.
Ironically, the legislators' social goals were themselves hardly
attaiLned. Those affiliates who received mortgages or assistance laws, or
rent-controlled housing indeed received a windfall. But their number was
89 -
reduced. Moreover, the social policies prejudiced the institutions'
solvency and impaired their ability to extend even those benefits guaranteed
by law, not to mention increasing future benefits. Payroll taxes were
increased eight times from 1952 to the present in order to finance those
benefits which were considered 'acquired rights' for affiliates. In short, the bulk
of the affiliates paid rather dearly for the socially-oriented investment
policy designed to benefit them.
An equilibrium between social goals and financial principles
could have been found. The natural laws of economics cannot be denied forever.
In the long-run, failure to follow financial principles benefitted very few.
Other countries, notably Mexico and Ecuador have also acknowledge 'trust'
concept for their investment policy - but always subject to a minimum pro-
fitability constraint. Why Chilean legislators did not see fit to do this
remains somewhat of a mystery. Its explanation lies no doubt in the exis-
tence of a powerful and effective trades-union constituency, and the Chilean
democratic process. This, however, lies outside the scope of the paper.
The Choice of Financing Mode: Pay-As-You-Go vs. Capitalization
A proposed reform of the Chilean system- includes a plan to re-
establish a capitalized fund for the financing of old age and survivors'
pensions. There are as many arguments pro as con this decision.. The previous
section outlined the factors which brought about the degeneration of the ori-
ginal capitalized system which Chile had introduced in 1924,. to its present
1/ These are currently(1977) under discussion.
90
pay-as-you-go status. Lessons can and should be drawn from this past
failure. If the reimplementation of funding is to be successful, a
return to relative price stability will be needed and adequate regulation
to insure that investments earn some target rate of return is imperative.
On the benefits side, the policy will necessarily have to become less
"socially" oriented. The type of portfolio held by the funds is important
not only because of the need for an adequate return, but because the funds'
investment strategy has implications for resource allocation and may help
fulfill the government's development goals. In the Chilean context,
funding may especially difficult because of the immense coverage of the
system: the difficulties of placing and managing the surpluses grow with
the size of the fund. Finally, the increased costs, in the short and medium
run, of higher payroll taxes for the funds' capitalization must be considered:
Pay-as-you-go...? The Theoretical Case
Samuelson's consumption loan model first provided an attractive
economic rationale for the pay-as-you-go schemes. The model implied that with
a growing population and labour force, it was better to have a pay-as-you-go
system than a capitalized one, since the benefits paid out under the former
would always be larger than under the latter, as long as each generation, ad
infinitum, supported the preceeding one in accordance with the social contract.
This obtained because under a capitalized scheme, the effective "rate of
return" on social security (the benefits received for the Raid-in contributions) -
was constrained by the rate of return on investment in the economy (r). Under
the pay-as-y.ou-go mode, the constraint was the rate of growth of the labour
force plus productivity (n + d), Samuelson's 'biological rate of interest'.
1/ The present reform formulation envisages a 47% payroll tax rate. This impliesno change in the average absolute rate of tax operative now, but representsa tremendous change in the effective rate of taxation, since the neEi systemdoes away with all income ceilings. Of this 47%, 13 points, approximately,represent the surtax for capitalization.
- 91.
Assuming that 'technological change affected labor and capital productivity
equally, n + d was always greater than r. The pay-as-you-go scheme could,
therefore, generate a higher level of benefits than could the capitalized
fund, which could never offer a return higher than the profit rate.
The conditions under which the optimality of pay-as-you-go
financing held were, however, fairly restrictive. These were that there
be no store of value in the economy, and hence, no means of capital accumu-
lation. In Samuelson's scenario , everything was like chocolates, which would
melt, and could, therefore, not be kept or accumulated. In such scenario, no
savings were possible, and therefore, a social security scheme based on the capi-
talization of inpayments was. entirely infeasible. Samuelson's conclusion, that
a pay-as-you-go scheme, rooted in the social contract, was an efficient means of
"saving", must be regarded in this context.
In fact, all of Samuelson' s assumptions about the impossibility of
capital accumulation need not be met for pay-as-you-go financing to be optimal.
This will obtain as long as the economy's growth rate (n + d) exceeds the rate
of interest, r, as the following diagram shows.
(n~
The line aa', the consumer s budget line, represents the trade off between -
consumption in the two periods, with. slope -(1 + r). Alternatively, it can
be viewed as the rate at which a fully funded social security scheme,
earning 'r' on Its investments, can transform current social insurance
taxes (in amount of Ab) into future income (benefits> for the individual.
If instead a social ins.urance program is introduced and financed-via
a pay-as-you-go method, its implicit rate of return, as noted by Samuelson,
will be the population growth rate plus the rate of growth of productivity,
n + d. If n + d?r, the rate of transformation between present and future
consumption is given by line segment AB, where point b corresponds to the pay-
roll tax, i.e. to the maximum percentage of current income which is transformable
into future income via social security system,and therefore, at the rate (n + d).
Since the remaining income when saved can only be transformed into future
income at the rate (1 + r), the rate of return on savings, this is the slope
of line segment BC. When (n + d) is less than the interest rate, the budget
line is ADE, and pay-as-you-go financing is clearly worse than capitalization.
Because the Samuelson scenario assumes no capital accumulation, the long-term
growth and resource allocation implications of an unfunded system are completely
ignored.
The optimal growth rule (Phelps 1961, Cass & Yaari 1967) can also
be invoked to shed light on the financing issue. The situation described by
n + d 7 r corresponds to a situation of excessive capital intensity, where the
(declining) profit rate has fallern below the rate of growth,
and where consumption is less (and shrinking) than the maximum steady
state consumptiori, achieved where g = r. In this case, consumption will be
increased by reducing savings and returning to the optimal capital intensity
for the economy (which is what the pay-as-you-go system will achieve).
- 93 -
The,realistic situation depends on what country one is describing.
More often than not, g < r. The actual profit rate and the capital labour
ratio is low, this side of the steady rate maximum, where savings must be
increased (via funding of the social security system) to move towards the
optimum. -Here, pay-as-you-go financing is suboptimal, since consumption is
less than the steady state maximum, and the tradeoff between future and
current consumption less than it need be. It is on this reasoning that
Feldstein estimates the efficiency losses due to pay-as-you-go financing in
the U.S.
However, the optimal growth framework obscures many of the real
world aspects of any social security system. More often than not, social
security institutions do not invest-at the "profit rate", but at the government
bond or some other, always lower rate, r*. The wedge between r and r*
brings about a divergence between what is good for the economy, and what
maximizes the rate of growth of benefits for the recipients.
-,ay-as-you-go will provide
higher benefits (g + d > r*) but reduces the long-term investment and growth
rate of the economy: in the lingo of the day, it will not bring the economy
closer to maximum steady state consumption.
94
The International Labour Organization, on a much less arcane level
than that of Samuelson or the optimal growth models, has also been a propo-
nent of pay-as-you-go systems. A dominant theme in its social security
literature- throughout the 1960's was the implications of payroll taxes
for employment. Capitalized funds were held to have a very high cost in
terms of labour displacement, higher than unfunded systems, since a highez
initial rate of tax is required while the reserve fund is built up. If
shifting of the tax takes place, and wage earners absorb the tax, the
capitalization premium then raises the cost of pension coverage for them. In
short, the capitalization premium was held to make the systems "unnecessarily
expensive", and pay-as-you-go was to be preferred.-/ Funding was necessdry,
it held, for small, private pension. funds, but not for compulsory public
insurance programs.
1/ International Social Security Review, ILO, Geneva.
2/ See footnote, p. 91.
- 95 -
or Capitalization?
Quite the other extreme is proposed by Feldstein (1974c) who
advocates full funding of a social insurance system. The system, in
Feldstein's schema, is fully funded when the size of the accumulated reserve
fund is such that the income it generates alone is sufficient to pay out all
pension benefits each year, for all future generations, and so that payroll
taxes are no longer required. This differs from the traditional understanding
of funding, which simply implies that all income to the system, less that
portion al ocated to administrative expenses, is invested to pay out future
benefits. The advantages of Feldstein's scheme are that the capital stock
is increased , implying faster growth and a higher wage share, with future
workers freed of the payroll tax burden. The cost, of course, is that payroll
tax rates on the present generation of workers must be raised, raised quite
substantially.-L/ The present generation will be willing to pay this, since
the bulk of them will themselves be beneficiaries: If "endowed financing"
is brought in quickly, a new labour force member will pay, the higher rates
for some 5, perhaps 10 years, but will pay no tax at all for the remainder.
With 'reasonable' rates of time preference and the right age distribution,
democratic choice (i.e. the workers will themselves vote for it) will lead to
the establishment of a fully funded soaial insurance system.
1/ In Feldstein's example, the size of a fund for "endowed financing" inthe U.S. must be about $600b. This can be established in 5-6 years,with a doubling of the present payroll tax to 20-25 percent.
- 96 -
The Feldstein proposal has undoubtedly gone much further than any
previous discussions of funding. Two aspects of the argument are troublesome.
The size of the proposed fund is enormous. To suggest this for Chile, for
example, implies a fund 25 times the current annual payouts of the system,-'
assuming benefits remain constant in real terms. This is some 9 times the
total outstanding amount of government securities in 1975, and 7 times the
total amount of domestic credit outstanding - even in the U.S., however, the
amounts involved are staggering. Secondly, the arguments about democratic
choice do not convince. Funding the social security system for future
generations may make little sense to the present generation whose standard
living is lower, and a fortiori, if the system becomes funded, since future
generations not only reap the benefits of no payroll tax, but also of higher
growth and technical change generated by the jump in the saving rate.
Capitalization and the Refo6rm Proposals in Chile
If Chile is to undertake anew, the funding of its social insurance
system, it is obviously not the Feldstein extreme for which it wi11 opt, but
the common funded system in whici accumulated taxes plus interest income
provide the source from which pension benefits are paid. The extreme of this
is the provident fund in which risks are not pooled, and where the "tax plus
interest equals benefits" mechanism operates for each individual. More
commonly, capitalized systems do admit some redistribution - precisely because
social insurance not private - is being provided - with the provision that no
pension liabilities with the system as a whole remain unfunded.
1/ Assuming a real interest rate of 4 percent.
- 97 -
In principle, and subject to the theoretical provisions about the
rate of return on assets, a capitalized pensiou, system is preferable. Its
advantages with respect to savings mobilization and.capital accumulation,
the ability of government to allocate such additional resources in keeping
in its development strategy; these are indisputable. Nonetheless, with res-
pect to Chile, there are three factors which suggest one proceed with caution
in this direction and suggest that the decision to refund may be a bit
premature still. These are (1) continuing inflation at above-normal rates,
(2) past .history and evidence of continued instability in financial markets,
and (3) the limited abscrbtive capacity of financial markets. Finally, a
capitalized system implies by definition, a strict benefit policy, and limits
the extent to which the system can extend adequate coverage to "poor risks".-/
Capitalization wiould thus imply a very new emphasis for Chile, where the tra-
dition, since the 1940's has been one of redistribution, with liberal coverage
for precisely those poor risks the norm, rather than the exception.
If funding is to have any chance of success, the annual cash surplus
must be investable at a return which permits asset values, whether real estate
or whatever type of security, to remain intact. The investment strategy
pursued by the social security system affects in the most integral way the
structure of the system, and the benefits it can pay out. For example, a one
percent ijncreaseinthe interest rate earned on the reserve fund will cut
the cost of providing a guaranteed level of benefits by as,much as 25 percent.
Thus for funding to make sense, the profitability of investment, in real terms
1/ It also limits the extent to which benefit increases can be used forpolitical means.
- 98 -
must be assured. Should this not be possible, real benefit levels can
only be maintained by increasing thr contributory rates on wages. At certain
inflation rates, even this would not suffice, because they could not rise
beyond tolerable levels; if a breakdown is to be avoided, benefit levels
simply have to be reduced. This, of course is not usually what happens, for
it is the adherence to the funding principle which is sacrificed before
benefit levels suffer.
In the conditions of hyper-inflation such as Chile has experienced
since 1970, the nominal interest rate required to keep real rates above zero
would simply be intolerable; and certainly unsustainable from an economic
point of view (some 20 percent per month, for example in 1973-74). While
interest rates have been fairly high since the 1974 revision of the usury
sanctions in the civil code, they have been accompanied by a period of
unusually great instability in financial markets. Once liberated from res-
trictions, the banking sector and the financieras have both maintained very
aggressive interest rate policies in pursuit of deposits. The 1974-77
period has been characterized by great instability, bankruptcies have been
common, accounts in the national savings and loan system were frozen to enable
banks to reestablish their liquidity. In short, the private sector does not
offer the rlsk - return combination requisite for assets of a pension fund.
At this point, moreover, it offers no long-term maturities, which are the
traditional mainstray of/pension fund, and on which interest rates are generally
higher. A portfolio of 30-and 90-day securities simply can not provide the
fund with the planning horizon it needs.
-99-
If the funded system is to have the desired effect on resource
allocation, the portfolio choice of the institutions becomes constrained to
those assets deemed desirable by the authorities. Many countries have found
no incompatibility between these goals and the funds' interest assumption,
Singapore has used the social insurance surpluses for a very successful public
housing scheme; Sri Lanka, Philippines and Malaystainvest in government securities
whose interest rates do not differ substantially from the return on private
securities. On the other hand, the strains in Chile have been constant,
The present government is eager to see the advantages of a
capitalized system. The aggregate amounts are large: some 3-5 percent of
GNP is collected each year in payroll taxes for pensions, which would more
than double the present private savings rate. The potential of capitaliza-
tion in developing the capital market and opening up closely-held corporations,
and providing new channels of finance for industry are additional attractions,
On the other hand, the government is also well aware'of the difficulties noted
earlier regarding the required rate of return, and the breadth and safety of
the capital market, All of these facts imply that a brusque introduction of
capitalization is quite infeasible.
To ease the transition, the government plans to permit the funds to
purchase indexed government bonds; the rates offered will be about 5-6 percent
(real), and they will have 6-7 year maturities. Nontheless, because of fears
of a recurrence of past misuse of funds, especially the 1974 debacle, they are
1/ Because of its past experience with the housing program, the governmentis not so keen on the 'resource allocation potential' of social securityfunds.
- 100 -
'loath to encourage the cajas to hold public securities.-L/ To stimulate the
holding of private securities, there are plans to offer a minimlm guaranteed
return on the portfolio to the funds. The cost of this guarantee will vary
with the course of market returns and interest rates, which in turn is a
function of monetary and financial policy. A priori, there is no means of
judging the potential expense of this guarantee. It is quite possible that
if inflation persists at the present rates (approximately percent per
annum) and if the recovery of financial markets lags, that this guarantee may
become as much a burden to the government as the subsidies it presently pays.
The new scheme may simply represent a change in form rather than sub-stance.
A secondary danger is inherent in the present plan. Because the
blue-print permits individuals to purchase additional "insurance" (i.e. higher
pensions) for themselves by paying in higher than minimum contributions, this
may draw savers away from other financial institutions. The shiftin financial
markets may reduce the viability of the usual savings institutions and would
also mean that the potential cost of the guarantee is much increased.
The size of the annual cash surplus to be invested even assuming benefit
levels remain constant, is hard to judge. Official figures are in the US $130-170
million range. Recent figures do not give much indications of future trends because
of the high rates of unemployment which reduced payroll tax collections and the deep
economic recession of 1974-77 during which evasion rates of employer and employee
taxes became extraordinarily high. Moreover, the changes in tax rates,
in .proportion of income subject to tax, etc., all make extrapolation of
1/ Extensive holdings or government securities, moreover, is at odds with thegovernment' s "divestiture" policy and intentions to turn social insuranceover to the private sector.
-101-
of the recent trends invalid. The official figures, in any case, imply a.
doubling of the present surplus. In comparison with total private and
public debt, they would make up approximately 30, and 5 percent respectivel]y.A/
In sum, the two difficulties foreseen in the reform plan are the
interest rate guarantee, and the absolute amount of the fund. Difficulty of
managing the investments will grow with the maguitude of'the funds. Capita-
lization poses no problems in small schemes, where coverage is restricted, or
benefits low. The investment of cash surpluses represents a drop in the
bucket. Capital markets can easily absorb it, and be stimulated and devel-
oped. In short, until inflation is under control Cand a reduction from
150 percent (1976) to " percent (1977) is probably not enough) a recovery of
capital markets complete, one must be somewhat sanguine about the soundness of
a reform based on capitalization, which is best re-established once a period
of relative price stability has been achieved.
The above caution, it should be noted, refers to the short-run only.
In the long-run, in a.period of financial stability, when the advantages of
capitalization can be reaped, it is undoubtedly the right choice for Chile.
1/ International Financial Statistics.
- 102 -
SECTION IV
Social Security and Lifecycle Savings; A Theoretical Exposition
The lifecycle savings hypothesis is firmly rooted in traditional
micro theory, Each individual is assumed to have a consistent preference
function over his lifespan which he will maximize subject to a lifetime
budget constraint:
Max . U = UCC1 , C2, c 3 ! c, B)
subject to; Y a , ct(l + i) -t + B z i( +
where c refers to consumption in period t,
and B (which may be equal to 0) represents the bequests which the individual
intends to leave behind, and R, the retirement age.
In a simplied two period (Fisher, Harrod) framework, assuiming a zero
rate of time preference, the individual will wish to equalize his consumption
in each period, so that C1 C2 -. Diagramatically, this is determined by
point A,
CL
where tangency between budget line with slope -(l+r) and the individual's
indifference curve occurs, The 45- expansion path is generated by the
"Hemingway assumption" (homethetic indifference curves) which insures that
C1 - C2 C regardless of income level. The rich thus exhibit the same inter-
- 103
temporal consumption preferences as do the poor, they just consume more in
each period.
If the first period represents the individual's economically active
period, and the second the period of retirement, the income stream over the
lifecycle will be described by::
0 4 t 4 (1-R)TYtt
t . t > (1-R)T
where T total lifespan,
and R = # of years in retirement,
and T(l-R) the years spent in active employment.
For consumption In retirement to be the same as consumption while
employed, savings during the first period will have to be sufficient to cover
consumption during the second, when income falls to zero.
The lifetime budget constraint (assuming for simplicity that the
income stream is constant) in this notation becomes
Y y Yt (1-R)T
and if there are no bequests, then
y a Yt (1-R)T - C
will also hold since savings over the lifecycle are zero. Consumption each
period, donoted by ct, is then:
ct = C/T - (l-R)yt
and savings (yt - ct) therefore,
St = Yt - (l-R)yt
or simply,
St Ryt,
incomes times the percentage of lifespan spent in retirement (R).
- 1.04 -
In the lifecycle model then, labour force participation decision
and income jointly determine the rate of savings. The longer the period of
retirement, the greater will be personal savings.
The "induced" retirement effect and the substitution effects of
social security can be incorporated into this framework by incorporating
leisure into the utility function, so that an income/leisure tradeoff is
introduced (Feldstein 1976). The utility in each period is described by the
function
Ui - u (Ci, Lij)
When social insurance is introduced, consumption in retirement derives from
own income and from.social security benefits, Tae utility function thus,
becomes
Ui u(Bi +. [(l-Li) (l-t)], Li)
where (1-Li) represents labour income in period i and (l-t) represents the
payroll taxes used to finance social insurance. and B, the pension benefits
Feldstein shows that at the utility maximum,
dL > OdB
An increase in benefits leads to an increased demand for leisure(early retirement).
The sign of dS , however is indeterminate.dB
- 105 -
Rationale for the Lifecycle Approach in Chile
Because Chilets social security syst'em is so comprehensive, and
the benefits such that almost every conceivable risk and contingency-is
covered, the likelihood that behaviour should have remained unaffected
is very small. Census figures show a decline in the labour force partici-
pation amongst the aged, indicating that increasing numbers are retiring
earlier. Whereas in 1952, 70 percent of the male population over 65 was
still economically active, by 1970, this figure has shrunk to only 40 percent,
and a further decline has been noted in the 1970-76 period.-L/ Since early
retirement on 'seniority' pensions is an option open to all government and
most private sector employees, with little diminution in benefit levels,
there appears to be little incentive for this subset to continue in the labour
force after reaching the eligibility age. Pension fund data show that the
ratio of seniority pensions - to old age retirements exceeds three to one in
the public sector, and is.just slightly less in some of the private employees
funds.-2 In short, it is apparent that retirement behavior has changed quite
drastically in the past three decades,and that the growing coverage and relative
generosity of the pension system may in part be responsible for this. How this
L/ Catherine Pierce: Demographic Brief, Chile, 1976, IBRD.
2 "Antiguedad", as opposed to "vejez", which refers to old age pension.
3/ P. Gregory: Country Economic Report, Chile, 1977, forthcoming.
- 106
induced retirement has affected savings, and the extent to which it may
offset the decline in savings expected from the benefit substitution effect
cannot, of course, be determined a priori, but only from empirical estima-
tion. Induced retirement and asset substitution are both a function of the
level of benefits an individual expects to receive. The higher the expected
pension, the less harsh will be the transition from working to retirement,
and the greater will be the retiree's inducement to withdraw from the labour
force. The more closely the pension anproximates the preretirement income
level, the less own savings will be needed to supplement the pension for
post retirement consumption to be brought up to the desired level. -
The aggregate level of pension benefits, in 'a pay-as-you-go system
such as Chile's is a function of (1) increased coverage, (2) higher wages,
which provide a higher tax base from which pensions can be paid, (3) a higher
tax rate itself, and (4) faster rate of population growth, also increasing
the wage base. In the aggregate, only (2) is likely to provide a basis for
the expansion of future benefits in Chile. Coverage is already extensive,
the age distribution of the population is very "European" in character, that is,
the ratio of retired to economically active is high and growing, rather than the
reverse, and the tax rates are already at impossible levels. Thus, structural factors
do not point in the direction of increased benefit levels. A priori, therefore,
one might expect that the (presumed positive) induced retirement effect on
savings is likely to decrease in strength, and its ability to outweigh or
offset the (presumed negative) effect of asset substitution will be reduced.
In any event, the relative strengths of these two effects cannot
be ascertained except through empirical estimation. The following section
will discuss the econometric specification of the savings function and the
manner in which the induced retirement and benefit level effects have been
incorporated into it.
- 107 -
Social Security and Savings: Empirical Evidence for Chile
A two equation model is used to estimate the savings behaviour
and retirement patterns observed in Chile. The rationale underlying this
formulation is that individuals frame their i-etirement decision on the
basis of their anticipated post-retirement income, and that retirement
plans, in turn, serve as the basis for savings patterns.
(1) R - f(SSSRR, PC)
(2) S - h(R, SSPR, PC, Y, DR)
R - expected number of years in retirement
SSRR - ratio of social security benefits to income, the"replacement ratio"'
PC - proportion of the population covered by social security
S - private household discretionary saving
Y - disposable income
DR - dependency ratio
The first equation shows the functional dependence of the retirement
decision on the level of social security benefits and the percentage of the
population covered by these benefits. Equation (2) describes the savings
function and illustrates the two countervailing effects of social security on
the savings decision. The direct, substitution effect (via SSRR) which is
hypothesized to reduce private savings; and the indirect impact, via an induced
lowering of the retirement age (R) which should increase them.
- 108 -
The actual equations will be of the form:
(1) LF65M ' + PC + SSRR1 2 c 3 SR
(2) S B + 2Y + B3PC + B4YLF65M + B5DR + B6 ( SSRR~ B2 +B3 5 6 TA.XR
COLMBRLCBTAXR
In equation (1) the retirement decision (LF65M) is influenced by the
level of pension benefits, and the percentage of the labouw force which
is affiliated to the social security system.
'The specification of the savings function (2) is somewhat of a
composite. The social security variable (SSRR) is intended to measure the
substitution effect of pension levels on discretionary savings and its
sign is expected to be negative. Since in the lifecycle framework savings
are a function of age, the retirement variable YLF65M also enters. The
dependengcy raLtio is included in the equation on the grounds that since dis-
saving (or, expenditures by parents on behalf of children) is characteristic
of the early part of the lifecycle, changes in the age distribution of the
population also affect savings. Its sign is, of course, expected to be
negative. A larger population affiliated to the social security system (PC)
will reinforce the impact of the early retirement and substitution effects.
The greater the affiliated population, the more important even a small subs-
titution effect will be.
The Data
Retirement. (LF65M). Ideally, the variable which should be used here is
the number of years and individual expects to spend in retirement, since
it is the expectation of the length of retirement on which the savings decisions
- 109 -
are based. However, since no data of this sort, even on actual years of --
retirement is available for Chile, following Munnell, (1974 b), labour force
participation rates of the population over 65 age are used as a proxy. This
age can be justified on the grounds that in Chile, as elsewhere, the eligibi-
lity age for most pensions is 65 years. Anticipated benefits will, therefore,
induce withdrawal from the labour force at this age, rather than the laien age
which might be chosen if the pension option were not available. If the eligi-
bility age varied widely amongst the plans, or if seniority pensions were pre-
dominant, the use of LF65M becomes less appropriate.. The source of the labour
force participation figures is the Census figures of the Instituto Nacional de
Estadisticag intercensal estimates were provided by Odeplan.
Population covered by Social Security (PC). The variable used here is the
ratio of affiliates to the potential pool of affiliates, the economically
active population. This was chosen on the grounds that it is the anticipa-
tion of pension coverage, rather than the actual receipt of a pension which
influences the retirement decision and the savings rate. Since all affiliates
are in principle eligible for pensions in the future, PC measures this
correctly. Feldstein (1976) uses a different variable, namely the ratio of
pension recipients to the population over 65 (and its retirement adjusted value,
pension recipients/retired population over 65), on the grounds that this
represents the fraction of the population which is effectively protected by
old age insurance. However, since it is the expectation of coverage, which
affects the savings decision of the economically active, it is preferable to use
the broader specification, PC.
- 110 -
Benefits (SSRR). The social security replacement level variable measures
the extent to which the pension can replace the pre-retirement income of the
worker, and is simply pension devided by personal disposable incooe. The
social security replacement variable is, in itself, also only an approxima-
tion for the true replacement level, since it ignores changes in earnings
over the life cycle. It is the replacement level relative to the earnings
in the years immediately preceeding retirement which are relevant to the
retirement and savings decision. Unfortunately, such specific data are not
available, since the Social Security Superintendency records only taxable
earnings, which do not correspond to total earnings because of exemptions,
ceilings, etc. The source of the pension figures is the Superintendency
of Social Security. Personal income is taken from the United Nations Yearbook
of National Accounts Statistics. Alternative formulations of this variable
are (1) the ratio of taxes for pensions to income (TAXR), (2) the ratio of
total social insurance benefits (health, maternity, family allowance, etc) to
income, the composite benefit ratio, (COMPBR), an& (3) the ratio of taxes
earmarked for these benefits to income (CBTAXR).
Savings: The savings series represents financial savings of households. Its
source is the International Financial Statistics (Time and Savings Deposits).
Dependency Ratio (DR). The dependency ratio is defined as the ratio of
persons less than 14 years of age, and over 65 to the number between the ages
of 14 and 65. The series is from the United Nations (Centro Latino-Americano
de Demografia) " Demographic Bulletin, 1976.
Where appropriate, the series have been deflated by the index of
consumer prices (International Financial Statistics). Values are expressed
in constant escudos of 1958. The sample contains .29 years.
Estimation of the Model
Table 22 shows the results of the ordinary least squares regressions
of the financial savings and labour force participation equations. While the
induced retirement effect (equation 5) appears to be substantiated, and in
turn the effect of early retirement on financial savings, there appears to
be no evidence at all of any substitution of pension entitlements for personal
financial savings. Quite on the contrary, savings and benefit levels appear
to be positively related. This is so whether pension benefits alone are included
(equation Itr whether the measure includes composite benefits (equation 2 ),
and also when the tax ratio is used as a proxy for "social security savings. (equatioi
3 and 4). There are numerous possible explanations for this result. One expla-
nation is that one would, ideally, want to focus in the savings equation only
on those who are in their pre-retirement years, and whose behavior, therefore,
would be more responsive to prospective changes in their post retirement
standard of living. Munell's results - in her reestimation of Cagan's data -
were extremely sensitive to this and could be interpreted as suggesting some-
thing about the time-horizon over which individuals plan. A second reason
lies in the choice of financial savings as the dependant variable. Once
again, it is savings for retirement, not total financial qavings, which should
be affected by the choice of retirement age and rising benefit levels. Munnell's
(1974 b) results, again, are sensitive to this difference in specification.
Table 22
Financial Savings Equations
C Y YLF65M DR PC SSRR COMLBR TAXR CBTAY.R R2
(1) 30.38 0.085 -0.18 -0.39 -0.60 40.37 .950(4.11j (1.97) (-1.47) (-3.79) (0.24) (3.9)
(2) 19.72 0.093 -0.197 -0.25 -0.55 31.38 .963(3.10) (2.55) (-1.92) (-2.79) (-0.27) (5.48)
(3) 18.73 0.117 -0.238 -0.257 0.89 33.92 .935(2.12) (2.43) (-1.74) (-2.05) (0.320) (2.59)
(4) 26.21 0.115 -0.308 -0. 364 4.55 0.709 .916(2.73) (1.96) (1.98) (-2.61) (1.24) ; (0.
Labour Force Equation
(5) 114.6 -67.28 -79 62 , 972(26.72) (-9.84) (-1.72)
iI
- 113 -
A third explanation has to do with the nature of pension coverage
in Chile, rather than with the limits of the data. Eligibility requirements
are so strict in some of the cajas, that they render the final receipt of a
pension much less than a certainty. It is possible that the unsecurity
surrounding pension coverage causes the substitution effect to disappear.
Finally, the coverage of the system, unusual in that it extends
over the working class, where saving propensities may it-e low, would also
reduce the substitution effect over the system as a whole. Financ'.al saving
would not be affected by higher benefit levels if those expecting these
benefits would not have saved in any case.1
Further study is clearly needed to measure the effects of social
security on personal saving with greater precision. Ideally, as noted earlier,
one should focus on retirement saving - and on those affiliates in the 10-15
years prior to their retirement. The former can be achieved using the annual
change in assets of life - insurance companies as an approximation for retire-
ment saving. To focus on the pre-retirement group, cross-section data on the
financial characteristics of the affiliates of the major cajas would be required.
The Impact of Social Insurance on Total National Saving
The net impact of social insurance on total savings is)as noted
earlier, the result of its effects on household, government and business savings.
Net savings of social security-
Annual cash surplus of social insrrance institutions
- loans to affiliates
- change in personal savings
- government subsidy to the system
- change in business savings.
- 114
Government
In Chile, the biggest offset to the gross savings mobilization
capacity of the social insurance system has been the government subsidy.
Tables 15 and 16 showed the annual cash surpluses of the social security
system, and the size of the government subsidy in relation to them. The
net-of-subsidy cash surplus has been reduced over the 1946-75 period, and
turned into a deficit, as column (3) of Table 15 shows.
The gross surplus as a fraction of total social security
receipts has fluctuated from 34 percent at the outset of the period to its
all-time high in 1953, of 40 percent of social security income. By 1967, it
had declined to 5.6 percent. -
The net-of-subsidy surplus, on the other hand (column 1) shows an
almost continuous downward trend, from its peak of 29 percent in 1946 to a net-
of subsidy deficit of 25 percent of receipts in 1971.
In short, without the government subsidy to the system, the savings
mobilization of the social insurance system is much reduced. The social insu-
rance system has not, it appears from these figures, been a net generator of savings
savings since 1966.
Personal
To estimate the full net impact, the effect on personal saving
must also be accounted for. The regressions shows no discernable decline in
this category, offsetting the small savings embodied.in the a=nual cash surplus.
Quite the reverse, savings may even have stimulated.
Business
There has been no attempt made to estimate the impact of social
insurance on corporate savings. Although payroll taxes are extremely high in
115 -
Chile, it is nonetheless assumed that these are successfully shifted. The
high rates of inflation and the effective protection given to domestic
industry make this assumption quite plausible. The effect of social insu-
rance on business savings is therefore assumed to be nil.
For 1967, the net savings impact' of the social insurance accumu-
lation, after accounting for these factors would bet
194,6 Cash Surplus
- 167.1 - Government Subsidy
- 19,4 - Loans to Affiliates 11
- 0 - Change in Business Savings 2/
+ 11.9 - Change in Personal Savings 3/
" 20,08 Net saving mobilized.by the socialsecurity funds,
This is some 10 percent of the original gross cash surplus mobilized
by the system, If it had been assumed that business saving had been affected,
of if, instead the coefficient on personal saving had been negative, as
expected, the net-of-subsidy surplus would be much closer to zero, perhaps
even negative, implying that, in the aggregate, social security does not
generate any net savings.
1/ This figure is an estimate. Personal loans to affiliates make up some10 percent of the portfolio of the system. This figure was used toestimate the percentage of the cash surplus invested in loans to members.
2/ Assumed not to change.
3/ Labour force participation rates declined from 43.3 to 42 from theprevious year, (1967 income is held constant to obtain the dollar value).The benefit ratio increase from 0.061 to 0.063; increasing financialsavings by $5.9 and $6.05, thousand pesos respectively, (see equation(2) Table 19).
- 116 -
Conclusions
In the Chilean case, the classical view of the savings potential
of social security does not appear to have been fulfilled. Generous, but
inadequately financed benefit policies with an income distribution emphasis
led to the switch from funded to pay as you go financing. Though the system
did generate surpluses, the government subsidy accounted for over half of
the surplus for muchx of the period (see Table 16) and towards the latter half
of the 1960's, when the public subsidy came to some 20-30 percent of receipts,
the :system's net-of-subsidy surplus turned into a deficit.
Inflation and poor portfolio management implied a rate of return on
the systems assets which was insufficient to maintain real asset values. Thus
those surpluses which did accumulate, were eroded quickly. The cash surpluses
of the system did not, therefore contribute significantly to national capital
accumulation, nor did investment income ever supplement payroll taxes as, in
actuarial system, it would have.
The Chilean social insurance system did not fit the classical resource
allocation model either, Percieved social imperatives guided the investment
policy into 'soft investments' for the benefit of the system's affiliates. By
definition then, the resource allocation impact in the traditional sense, -- the
social security system as a holder of government debt, deepener of capital
markets, new source of. industrial finance, -- was ruled out.
The confusion over how best to serve the needs of affiliates,
especially over the short and long run consequences of the chosen policy marred
- 117 -
even this objective. Failure to introduce adequate financial safeguards,--
the unrealistic rent controls, interest rates and grace perioda,,-- led to the
systems rapid decapitalization, and inevitably to the payroll tax explosion of
the 1950's and 1960's which brought tax rates for many institutions well over
60 percent. While some affiliates obtained a windfall from the policies
designed to benefit them, by far the majority paid rather dearly.
A reform of the system)proposed though not yet introduced, seeks to
reverse past trends, and has the traditional model of savings mobilization and
resource allocation well in mind. Its success depends on unswerving adherance
to a strict benefit policy; --the admission of non-actuarially determined
payments inevitably spells the end to full funding- and on the systems'
investment performance. With inflation at °;' percent per annum, the reestablish-
ment of a capitalized system may still be a bit premature.
- 118 -
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