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Crises and Pensions:Crises and Pensions:Lessons from the Global Lessons from the Global
Financial CollapseFinancial Collapsebyby
SEBASTIAN EDWARDSSEBASTIAN EDWARDSUniversity of California, Los AngelesUniversity of California, Los Angeles
May, 2010May, 2010
The three pillars of Chile’s The three pillars of Chile’s economic successeconomic success
Openness and international competitionOpenness and international competition Strong institutions and the application of Strong institutions and the application of
the rule of lawthe rule of law Pension system based on capitalizationPension system based on capitalization
Crises and pensionsCrises and pensions
One of the most remarkable aspects One of the most remarkable aspects of Chile’s privately run of Chile’s privately run
capitalization system is that it has capitalization system is that it has survived the crisis very well…survived the crisis very well…
Much better, indeed, than what some Much better, indeed, than what some international commentators and “international commentators and “gurusgurus” ” have been arguing in speeches around the have been arguing in speeches around the
world…world…
Value of Chile’s five funds in Value of Chile’s five funds in relation to the pre-crisis levelrelation to the pre-crisis level
-7%
0%
7%
14%
21%
Fondo A Fondo B Fondo C Fondo D Fondo E
Valor en comparacion a peak 11-07
Valor en comparacion a peak 11-07
Any serious analysis of the relative Any serious analysis of the relative merits and de-merits of the privately-merits and de-merits of the privately-managed capitalization system has to managed capitalization system has to
compare it to the alternative: compare it to the alternative: government-run regimes…government-run regimes…
… … and when this comparison is and when this comparison is done, the result are illuminating…done, the result are illuminating…
Government-run, defined-benefit, Government-run, defined-benefit, pension systems are in very serious pension systems are in very serious
shape… shape…
The main reason is that public The main reason is that public sector debts have exploded…sector debts have exploded…
Debt to GDP Ratio
0
20
40
60
80
100
120
USA Germany Belgium France Canada Greece Italy Portugal UK
Debt to GDP Ratio
The main reason is that public The main reason is that public sector debts have exploded…sector debts have exploded…
Debt to GDP Ratio
0
20
40
60
80
100
120
USA Germany Belgium France Canada Greece Italy Portugal UK
Debt to GDP Ratio
In contrast, Chile’s debt-to-In contrast, Chile’s debt-to-GDP ratio is only 9 percent!GDP ratio is only 9 percent!
… … worse yet, prospects are not worse yet, prospects are not good, going forward… projections good, going forward… projections
for the USA…for the USA…
0.0
25.0
50.0
75.0
100.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Net Debt as a Percentage of GDP Gross Debt as Percentage of GDP
… … and this is the “good news”… in and this is the “good news”… in reality things are much worse…reality things are much worse…
Government-run systems are not “marked to market”Government-run systems are not “marked to market” The recent strength of government bond prices hide The recent strength of government bond prices hide
the tremendous risks involved (although the Greek the tremendous risks involved (although the Greek crisis is beginning to change things)….crisis is beginning to change things)….
The true debt of government run programs are The true debt of government run programs are “hidden costs”; contingent liabilities that are not “hidden costs”; contingent liabilities that are not captured by conventional accounting…captured by conventional accounting…
It has been calculated that the “hidden” social It has been calculated that the “hidden” social security and Medicare debt in the US is security and Medicare debt in the US is 59 trillion 59 trillion USD ! USD !
In California, the government-run In California, the government-run pension system is in serious pension system is in serious
crisis…crisis…
It has recently been estimated that It has recently been estimated that the true shortfall of the three most the true shortfall of the three most
important government-run important government-run pension schemes exceeds half a pension schemes exceeds half a
trillion dollars…trillion dollars…
This has affected the lives of This has affected the lives of millions of people that have seen millions of people that have seen their net salaries reduced, and their net salaries reduced, and
their contributions to the pension their contributions to the pension system increase… system increase…
... it has even happened to modest ... it has even happened to modest
university professors…university professors…
Hasta la vista, baby!
Where is my pension?Where is my pension?
The recent European crisis of the The recent European crisis of the PIIGSPIIGS shows that unfunded pension shows that unfunded pension
systems can exacerbate a serious systems can exacerbate a serious crisis…crisis…
Unfunded pension obligations…Unfunded pension obligations…
0
100
200
300
400
500
600
700
800
900
Portugal Italy Ireland Greece Spain
Unfunded pension obligations as percentage of GDP in 2009
Unfunded pension obligations as percentage of GDP in 2009
From the news:From the news: ““Reforms in Greece’s pension system envisage Reforms in Greece’s pension system envisage
30% cut in the pensions and increase of the 30% cut in the pensions and increase of the retirement age with up to 15 years, Greek retirement age with up to 15 years, Greek Ta Ta NeaNea daily reports”. daily reports”.
““Greece on Sunday announced more austerity Greece on Sunday announced more austerity measures … through 2012, to be achieved measures … through 2012, to be achieved through … pension pay cuts…”through … pension pay cuts…”
Bond yields: Greece, Portugal and Bond yields: Greece, Portugal and selected Latin American countriesselected Latin American countries
2
3
4
5
6
7
8
9
10
11
12
Greece 5 year Mid Yield Portugal 5 year Mid Yield Brazil Yld to Mat
Chile Yld to Mat Mexico Yld to Mat
Other important Other important contributions of the contributions of the
privately-administered, privately-administered, capitalization systems…capitalization systems…
Contributions to long-term Contributions to long-term economic growth…economic growth…
Capital accumulation, requires savings
Productivity growth requires innovation and dynamic capital markets…
A well-designed privately-managed A well-designed privately-managed system – that is, one with a system – that is, one with a
“solidarity pillar” “solidarity pillar” – also helps – also helps reduce poverty and inequality…reduce poverty and inequality…
Challenges and pending Challenges and pending reforms for capitalization reforms for capitalization
systemssystems
A modest list of possible A modest list of possible improvementsimprovements
Encourage voluntary savings for old ageEncourage voluntary savings for old age Design properly company-sponsored and Design properly company-sponsored and
company-funded programscompany-funded programs Increase coverageIncrease coverage Implement mechanisms that deal with Implement mechanisms that deal with
people’s behavioral inertiapeople’s behavioral inertia Involve independent and informal workers in Involve independent and informal workers in
the systemthe system
Eliminate gender discriminationEliminate gender discrimination Increase the offer of investment fundsIncrease the offer of investment funds Add flexibility to portfolios (make Add flexibility to portfolios (make
investment limits flexible)investment limits flexible) Regulate the exposure of savings to risk Regulate the exposure of savings to risk
during years prior to pension decisionduring years prior to pension decision Implement a safety net that, without Implement a safety net that, without
discouraging contributions, provides a discouraging contributions, provides a minimum pension to poorer people (joint minimum pension to poorer people (joint with negative income tax)with negative income tax)
Reduce management costsReduce management costs Improve risk managementImprove risk management Design rules that reduce exposure to Design rules that reduce exposure to
sudden dips in market in period sudden dips in market in period immediately preceding retirementimmediately preceding retirement
SummarySummary The merits of a system is proved in difficult The merits of a system is proved in difficult
times, in times of crisestimes, in times of crises The privately-managed, capitalization based The privately-managed, capitalization based
pension regimes have shown to be robustpension regimes have shown to be robust To be sure, in many countries they could To be sure, in many countries they could
improve with reforms aimed at greater efficiency improve with reforms aimed at greater efficiency and better risk managementand better risk management
However, when compared with government-run However, when compared with government-run regimes the result are, by and large stellarregimes the result are, by and large stellar
Contrary to what some gurus have said, we need Contrary to what some gurus have said, we need more capitalization regimes, not fewer more capitalization regimes, not fewer