4a JORNADA IMPÉRIO SOBRE RISCO E SEGURANÇA E U R O P A R Q U E Santa Maria da Feira 20 de Fevereiro

SOCIAL SECURITY PRIVATIZATION IN THE UNITED STATES AND THE CHILEAN EXPERIENCE

L. Jacobo Rodríguez
Cato Institute
Washington, D.C.

Prepared for the 4th Império Risk Seminar, EUROPARQUE Congress Centre, Santa Maria da Feira, Portugal, 20 February 1997.

Introduction

British historian Paul Johnson wrote in 1991 that, "The state was, up to the 1980s, the greatest gainer of the twentieth century; and the central failure." [1] Indeed, for most of the 20th century, we have seen the almost unlimited growth of the state. On the domestic front, that growth, symbolized by the welfare state, has led to a decline in our individual liberties, to economic stagnation and, by substituting state coercion for voluntary exchange and association, to the destruction of the moral fabric of society. [2]

Unfortunately, the United States has not been immune to the growth of the state. As a result, those “inalienable rights to life, liberty and the pursuit of happiness” with which every man is endowed have been curtailed there as well. Indeed, so strong was the Framers' belief in those rights that, to protect them, they wrote a Constitution that granted the federal government limited and enumerated powers. As Thomas Jefferson wrote, “The sum of good government” is to “restrain men from injuring one another” and to “not take from the mouth of labor the bread that it has earned.” But, in the 20th century, the U.S. government has been taking, a lot. In 1900 public expenditures at the federal level were less than five percent of total output in the United States; by 1993, they had increased to about 24 percent. [3] The largest share of those expenditures goes to social welfare programs, none of which consumes more resources than the Social Security system that President Franklin D. Roosevelt established in 1935 as part of his New Deal. [4]

The U.S. Social Security System

The U.S. Social Security system is the single, most expensive government program in the world, spending more than $350 billion per year. [5] As a pay-as-you-go system, where benefits to current retirees are paid from the taxes of current active workers, it imposes a tax on the use of labor, which creates unemployment, and a heavy burden on today's workers. In addition, it depresses private savings and is headed toward insolvency, thus turning old age (for people who depend on Social Security benefits) into an age of financial uncertainty. It is a small wonder that Social Security "is the target of complaints from all sides." [6]

To understand the crisis of Social Security in the United States, we must look at the structure of pay-as-you-go systems. Once we do that, we realize that they have two intrinsic flaws. The first flaw is that old-age financial security has been made to depend on the political process. Social Security is a compulsory and impersonal government program that redistributes wealth among different groups and generations. Its universality is based on the false assumptions that people are irresponsible during their working years (and thus unable to plan for their retirement) and indigent during their old age (and thus unable to provide for themselves). The second flaw is that the substitution of political action for private action has severed the link between individual responsibilities and individual rights. In other words, individuals try to minimize their contributions to the system while they are active workers and to maximize their retirement benefits. [7]

In fact, because of those conceptual flaws, it was only a matter of time before the U.S. Social Security system would begin to confront the same problem that other public retirement programs have been facing for years--namely, how to keep the system afloat without reducing promised benefits or raising payroll taxes. But because of its inherent flaws and recent demographic trends, the U.S. pay-as-you-go Social Security system is headed toward bankruptcy.

Demographic Trends

The United States, like most industrialized nations, is experiencing two demographic trends that will make the financial bankruptcy of its pay-as-you-go system inevitable. On the one hand, people are living longer because of better nutrition and medical advances. On the other, fertility rates have declined in recent years and are expected to continue to do so in the near future. As a result, the support/benefit ratio--that is, the number of current workers per retiree--has been declining steadily, which in turn means that, to maintain the system, payroll taxes will have to be increased substantially in the coming years. [8] (Of course, some other piecemeal tinkering to the system, such as cutting benefits to pensioners or increasing the retirement age, can be done, but those options are politically less feasible.) Table 1 shows life expectancy figures and total fertility rates for the United States from 1945 to 2030 in 5-year intervals, while Table 2 shows the support/benefit ratio and payroll taxes for the same period:

Table 1
Demographic Trends in the United States, 1945-2030

		Life Expectancy
		At Birth		At Age 65
Year	Fertility	Male	Female	Male	Female
1945	2.42	62.9	68.4	12.6	14.4
1950	3.03	65.6	71.1	12.8	15.1
1955	3.50	66.7	72.8	13.1	15.6
1960	3.61	66.7	73.2	12.9	15.9
1965	2.88	66.8	73.8	12.9	16.3
1970	2.43	67.1	74.9	13.1	17.1
1975	1.77	68.7	76.6	13.7	18.0
1980	1.85	69.9	77.5	14.0	18.4
1985	1.84	71.1	78.2	14.4	18.6
1990	2.07	71.8	78.8	15.0	19.0
1995	2.04	72.3	79.2	15.4	19.2
2000	2.02	73.0	79.7	15.6	19.4
2005	1.99	73.9	80.2	15.9	19.5
2010	1.96	74.5	80.5	16.1	19.7
2015	1.93	74.9	80.9	16.3	19.9
2020	1.90	75.3	81.2	16.5	20.1
2025	1.90	75.6	81.5	16.7	20.3
2030	1.90	76.0	81.8	16.9	20.5
Source: 1996 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (Washington: Government Printing Office, 1996), page 61.

 

Table 2

Year	Support/Benefit Ratio	Payroll Taxa
1945	41.9	2.00
1950	16.5	3.00
1955	8.6	4.00
1960	5.1	6.00
1965	4.0	7.25
1970	3.7	8.40
1975	3.2	9.90
1980	3.2	10.16
1985	3.3	11.40
1990	3.4	12.40
1995	3.3	12.40
2000	3.2	14.59b
2005	3.1	14.59
2010	2.9	14.59
2015	2.6	14.59
2020	2.4	14.59
2025	2.2	14.59
2030	2.0	14.59

_________________________________________________________________

NOTES:
a. This tax is shared equally by the employer and the worker. However, from an economic point of view, virtually all the payroll tax is borne by the worker and is deduced from her marginal productivity.
b. Government estimates.
Sources: Ibid., p. 33, 122.

Social Security actuaries estimate a payroll-tax structure like the one shown in Table 2 will keep the system solvent for the next 75 years. [9] However, the 1983 National Commission on Social Security Reform also stated that a small increase in the payroll tax would secure the system for at least the next 75 years. 14 years later, that statement sounds overly optimistic. Thus, it is evident that payroll taxes will have to be substantially increased in the United States. But, as the experience of most Western European countries has shown, high taxes on the use of labor have strong negative effects on the rate of permanent hiring, wage growth, private savings [10] and, possibly, fertility rates. [11]

The Myth of the Social Security Trust Fund

Additional problems arise from the fact that the Social Security Trust Fund--that is, the account set up at the U.S. Department of the Treasury where all payroll taxes are deposited--is no trust fund at all, but rather an accounting illusion that conceals the real size of the U.S. federal government. First of all, since the trust fund has a positive cash flow (i.e., payroll taxes plus taxes on benefits exceed outlays to current beneficiaries), the federal government has been borrowing the surplus money to meet current operating expenses in exchange for Treasury notes that are credited to the trust fund. But those notes are neither real assets nor a claim on real assets; rather, "they represent a claim based on the government's ability to tax wealth created at some later time by the next generation of participants in the economy." [12]

So long as the cash flow remains positive, the illusion can be maintained. However, beginning in 2012 (according to the government's own estimates), the cash flow will turn negative. At that point, the Treasury notes that the U.S. government has been depositing in the trust fund during all these years will have to be redeemed. [13] The problem is that the U.S. government does not have the cash to pay off those notes, which means that it will have to raise taxes, reduce benefits or borrow more money. However, even after the government found a way to redeem the notes, the Social Security Trust Fund will nevertheless be depleted by 2029. [14]

Thus, although the U.S. Social Security system may be in better financial shape than most pension systems in Europe, some of which consume more than 10 percent of GDP and require large government transfers to cover current outlays, it is nevertheless headed toward bankruptcy unless radical changes to the system are implemented soon. That is not a prediction, but rather an actuarial fact, which many policymakers have finally acknowledged. In fact, there now seems to be a consensus on the need to reform Social Security. [15] (Only a few years ago, Social Security was considered the "third rail" of American politics--touch it and your political career is dead.) However, there is disagreement on the kind of reform needed to preserve the system. That disagreement is reflected on the report recently issued by the Advisory Council on Social Security.

The Advisory Council Report

In 1994, an Advisory Council on Social Security was created to address the long-range financial status of the Social Security system and "to analyze the relative roles of the public and private sectors in the provision of retirement income, particularly how underlying policies of various public and private programs, including relevant tax laws, affect retirement decisions and the economic status of the elderly." [16] In its report to Congress, released last month, the 13-member panel offered recommendations along three very different lines. One group of council members recommended a maintenance of benefits (MB) plan. Under that plan, the benefit and tax structure of the present system would remain intact, but benefits would be reduced and payroll taxes would be increased by 1.6 percent. Not only are those proposals insufficient to remedy even short-term financial difficulties, as evidenced by the frequency with which they are implemented, but they fail to address the conceptual flaws of the system that are the cause of all those difficulties.

In addition, under the MB plan, the government would invest (although not immediately) about 40 percent of the trust fund's money in the stock market to guarantee a better return. But, as Krzysztof M. Ostaszewski, the actuarial program director at the University of Louisville, wrote in a recent Cato Institute study, "allowing the government to invest the trust fund in private capital markets would amount to the `socialization' of a large portion of the U.S. economy. The federal government would become the nation's largest shareholder, with a controlling interest in nearly every American company" (1997: 1). Indeed, government ownership of the means of production has been tried before--most notably in the Soviet Union for 70 years--and it failed miserably. To believe that a greater dose of socialism can save Social Security is a fatal conceit that will destroy both Social Security and, in this case, the stock market.

Two members of the panel recommended a publicly-held individual accounts (IA) plan. The main provision of the IA plan is the creation of government-held pension savings accounts funded by an increase in payroll taxes of 1.6 percent. Again, while that plan also acknowledges that the stock market provides a better return on investments, it also fails to address the structural flaws of the system.

The third proposal, supported by five council members, transforms the current pay-as-you-go system into a two-tier system with privately-held individual accounts. The plan is in essence the only plan that offers the partial privatization of Social Security. Under that plan, the first tier would provide a flat retirement for full-career workers on a pay-as-you-go basis, while the second tier would offer defined-contribution, individually-held, pension savings accounts. Those accounts would be funded with 5 percentage points of current payroll taxes. Although the third plan is undoubtedly the best of the three, it stops short of eliminating the structural flaws of Social Security and, thus, will not prevent its eventual bankruptcy, only delay it for a longer period of time than the other two.

Indeed, only a system that removes the two structural flaws of pay-as-you-go systems will guarantee both the long-term solvency of the system and adequate returns on the contributions made. But, to depoliticize Social Security and offer individuals property rights over the contributions they make require the full privatization of Social Security, which is exactly what Chile did 16 years ago.

The Chilean Experience [17]

In 1980, Chile decided to replace its government-run, pay-as-you-go pension system with a mandatory system of individual pension savings accounts (PSAs). Since the reform was implemented in 1981, pensions in the new system have been 50 to 100 percent higher than they were in the old system; the resources administered by the private pension funds are now equivalent to 40 percent of GNP; the average annual growth rate of the economy has increased to 6.5 percent during the last 12 years; the unemployment rate has gone down to about 5 percent; and the Chilean savings rate has increased to about 27 percent of GNP. That exceptional macroeconomic performance can be attributed in part to Chile's private pension system.

The Chilean PSA System

Chile's PSA system is a defined-contribution system. Each month, workers are required to contribute 10 percent of their wages to their own, individual Pension Savings Account. [18] Those tax-free contributions have replaced the payroll taxes that both employers and employees were required to pay under the pay-as-you-go system. Thus, for Chilean workers, pensions now depend on the contributions made during their working lives as well as on the returns earned on those contributions, rather than on the ability of their government to tax future generations of workers.

Also, if a Chilean worker wants to retire early or obtain a higher pension upon retirement, she can contribute up to an additional 10 percent (also tax free) of her monthly salary to her PSA.

PSAs are invested in security portfolios managed by private Pension Fund Administration companies (better known by their Spanish acronym, AFPs). These AFPs and the pension funds that they administer are two separate legal entities, which ensures both transparency and security. Further security is provided by a government agency, the "AFP Superintendency," that oversees the AFP companies and sets limits on the kind of investments that the AFPs can make. [19] Of course, there is free entry and exit to the industry, and the AFPs compete with each other to obtain the workers' accounts by offering better service, lower commission fees, or better returns.

The PSA system was designed in such a way that workers have a great deal of flexibility and options when planning for their retirement. That was done because "individual preferences in old age differ as much as any other preferences," and the PSA system allows "those preferences to be translated into individual decisions that will produce the desired outcome." [20] Workers have a PSA passbook and every three months receive a statement informing them how well their pension funds have performed and how much money they have accumulated. Consequently, a Chilean worker can change his retirement plans accordingly.

Further flexibility is provided by the computer simulation programs that can be found in the offices of most AFPs. Those programs allow a Chilean worker to calculate the expected value of her future pension or the percentage of her salary that she must contribute to her PSA to retire with a given pension or at a given age. Once she does that, she can then tell her employer to make the necessary changes to her contributions.

Moreover, unlike traditional pay-as-you-go systems, which have set retirement ages, the PSA system does not have retirement ages. Instead, it requires that workers contribute to their PSAs until they have accumulated enough funds in their accounts to retire with a pension equal to at least 50 percent of their average annual salary during the last 10 years of their working lives. (The pension must also be higher than the legally defined minimum pension.)

Finally, it is worth noting that flexibility has not come at the expense of security. For those workers that have contributed to the system for 20 years, the government guarantees the minimum pension if and once their PSA has been depleted. In addition, there is a welfare-type pension for those workers without 20 years of contributions. [21] The AFPs also provide life and disability insurance for their customers by purchasing a group insurance policy from private insurance companies.

Chilean workers may choose between two different payout options upon retiring. The first option is to use the money in the PSA to purchase a life annuity from a private insurance company. Those annuities include survivor benefits for dependents. The second option workers have is to make programmed withdrawals from their PSAs based on their (and their dependents') life expectancy. Should a Chilean worker die before the money in his PSA has been depleted, that money becomes part of his estate. Finally, in either case, a Chilean worker may withdraw in a lump-sum the money in excess of that needed to provide a pension equal to 70 percent of his last wages.

The Transition

Any transition from a pay-as-you-go system to a private pension system must take into account the fiscal resources of the government and the special circumstances of each country. In general, however, a successful transition should include the following "Three Golden Rules" that Chile followed:

1. Do not accumulate more debt. Because the pay-as-you-go system is unsustainable, the door to that system must be closed to all new entrants to the workforce.

2. Give workers a choice. Workers that are already contributing to the government-run system must be given the option of remaining in that system or moving into the new private system. In Chile, those who moved to the new system--about one-fourth of the labor force in the first month of operation alone--received from the government a "Recognition Bond" that acknowledged the contributions workers had already made to the old system. The government will redeem those bonds when workers retire.

3. Honor your promises. The Chilean government guaranteed the pensions of those workers who had already retired so that they would not be affected by the reform. As Piñera explains, "it would be unfair to the elderly to change their benefits or expectations at this point in their lives" (1996a: 9).

To finance the transition, the Chilean government decided to use a multi-layered approach. First, it issued new debt to help pay for the transition costs. Second, it sold state-owned assets to offset the loss of revenues from Social Security taxes. Third, it imposed a Temporary Transition Tax on the use of labor. However, because contributions under the new system are lower than under the old system, net salaries for workers who moved to the new system increased and total labor costs for employers decreased. Fourth, the need to finance the transition fostered a culture of fiscal responsibility and frugality. As a result, wasteful government spending has been reduced drastically. And fifth, the reform has produced a virtuous circle by promoting faster economic growth, which in turn has led to an increase in tax revenues.

Chile's PSA System After 16 Years

Almost 16 years after the system was implemented, Chile's private pension system can be considered a phenomenal success--especially when one considers that it was the first attempt at Social Security privatization. Today, there are about 15 AFPs managing an estimated $25 billion in pension funds, an amount equivalent to approximately 40 percent of GNP. That amount is expected to grow to 134 percent of GNP by the year 2020. [22] Real rates of return have averaged over 12 percent since the system was implemented on May 1, 1981. Consequently, pensions under the new system have been much higher than under the old pay-as-you-go system. In fact, a recent study shows that the average AFP pensioner is receiving an old-age pension that is equivalent to 84 percent of her average salary during the last ten years of her working life. [23] Today, more than 90 percent of Chilean workers--about 5 million workers--are affiliated to the PSA system (although not all of them contribute to their accounts on any given month).

Furthermore, the structural flaws have been removed. Social Security in Chile no longer depends on the political process. It has ceased to be a redistributionist program where different groups compete against each other in the political arena to determine which group benefits at the expense of the other. Pensions are not affected by demographic trends or, like in some European countries, by the need to meet some convergence criteria. More important, Chilean workers now have property rights over their pension contributions. Thus, as one would expect, they care deeply about the value of their PSAs. They know that profligate government policies will affect their quality of life in old age and, as one would expect, they oppose them vigorously. Chile now enjoys fiscal budget surpluses.

Other Latin American nations have seen how Chile's reforms have led to better pensions for all workers, greater individual freedom and increasing prosperity. As a result, they have adopted reforms similar to the Chilean one in recent years. [24] In industrialized nations, however, many opponents of privatization still argue that the Chilean experience is not applicable to their countries. Yet, a recent study has shown that a prudent and gradual approach can make the transition to the new system fiscally viable even in a country with a mature pay-as-you-go system, an aging population and great fiscal imbalances. [25] In fact, there is reason to believe that industrialized nations would benefit from privatization even more than developing nations, since capital markets in the former countries are much better developed. Nowhere is that truer than in the United States.

The Benefits of Privatization in the United States

Harvard economist Martin Feldstein has estimated that the present value of investing the future cash flow of Social Security taxes in stocks and bonds is $15 trillion, or 5 percent of GDP per year in perpetuity. He has also estimated that, over the last 35 years, the rate of return on Social Security contributions has been 2.6 percent, while the real rate of return on nonfinancial corporate capital averaged 9.3 percent. Thus, “forcing individuals to use the unfunded system [has] dramatically increase[d] their cost of buying retirement income.” [26] In fact, under the present system, the real tax for which the individual gets nothing in return is 9.5 percent of total payroll. In other words, by shifting to a privatized system, contributions could be cut by nearly 80 percent without reducing benefits. Or, to put it the other way around, if individuals were allowed to put their payroll taxes in their own pension savings accounts, they would receive pension benefits that are five times greater than what they are getting now.

In the United States the poor would benefit the most from a privatized system, since they depend on Social Security benefits more than other socio-economic groups. Privatization, which provides better pensions, would ensure that the poor have financial security in their old age. In addition, a private system would eliminate the bias of the current system against them. Not only do poor people generally start to contribute to Social Security at an earlier age, they also die at an earlier age than people from other socio-economic groups--sometimes even before reaching retirement age. For instance, in the United States, the average lifespan of a black male is 65.4 years, which means that he enjoys the benefits of a Social Security system to which he may have contributed for more than forty years for less than six months. As a result, a system designed to help the poor in their old age ends up making them pay for the retirement benefits of the more privileged. (A privatized system, on the other hand, does not encounter that problem. It recognizes additional years of contributions by means of a better pension. More important, because people have property rights over their contributions, the possibility of contributing to a program that provides nothing in return--which is what happens in pay-as-you-go systems when people die before reaching retirement age--is eliminated.)

Conclusion

As the 20th century draws to a close, it is easy to see that the experiment in big government has been a failure, just as Johnson so eloquently showed in Modern Times. That failure stems from a false sense of morality that led politicians to establish--with the best intentions--the welfare state. But benevolence at the expense of others--which is in essence what public retirement programs amount to--has no moral credit. Quite the opposite, indeed, since it prevents individuals from behaving morally. As the Austrian economist F.A. Hayek said,

Freedom is the matrix required for the growth of moral values--indeed not merely one value among many but the source of all values ... It is only where the individual has choice, in its inherent responsibility, that he has occasion to affirm existing values, to contribute to their further growth, and to earn moral credit. Obedience has moral value only where it is a matter of choice and not of coercion (1996 [1962]: 50).

The Chilean system, a system that places the primacy on the individual and allows him the great satisfaction of providing for his own retirement, puts enough confidence on the ability of individuals to behave morally and responsibly when given a choice. And that is without a doubt the main reason for its success. In the end, only those government policies consistent with a just and free society--with human nature--are successful.

References:

Baeza, S., and Bürger, R. (1995) “Calidad de las Pensiones del Sistema Privado Chileno.” In S. Baeza and F. Margozzini (eds.) Quince Años Después: 165-75. Santiago: Centro de Estudios Públicos.

Borden, K. (1995) “Dismantling the Pyramid: The Why and How of Privatizing Social Security.” Social Security Paper No. 1 (14 August). Washington, D.C.: Cato Institute.

Crane, E. (1997) “Echoes of Advice the First Time Around.” Washington Times, 28 January: A16.

Dorn, J.A. (1996) “The Rise of Government and the Decline of Morality.” Cato's Letter No. 12. Washington, D.C.: Cato Institute.

Edwards, S. (1996) “The Chilean Pension Reform: A Pioneering Program.” Paper presented at the NBER Conference on “Social Security,” held in Cambridge, Mass., 1-2 August 1996.

Feldstein, M. (1996) “The Missing Piece in Policy Analysis: Social Security Reform.” American Economic Review 86 (2)(May): 1-14.

Feldstein, M. (1997) “Privatizing Social Security: The $10 Trillion Opportunity.” Social Security Paper No. 7 (31 January). Washington, D.C.: Cato Institute.

Friedman, M., and Friedman, R. (1990 [1980]) Free to Choose. Orlando, Fla.: Harcourt Brace Jovanovich.

Fuentes, R. (1995) “Evolución y Resultados del Sistema.” In S. Baeza and F. Margozzini (eds.) Quince Años Después: 73-97. Santiago: Centro de Estudios Públicos.

Hayek, F.A. (1996 [1962]) “The Moral Element of Free Enterprise.” In M.W. Hendrickson (ed.) The Morality of Capitalism: 49-57. Irvington-on-Hudson, N.Y.: The Foundation for Economic Education.

Johnson, P. (1992 [1991]) Modern Times (Revised Edition). New York: Harper Perennial.

Moore, S. (1995) Government: America's # 1 Growth Industry. Lewisville, Tex.: Institute for Policy Innovation.

(1996) 1996 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds. Washington, D.C.: Government Printing Office.

Ostaszewski, K. (1997) “Privatizing the Social Security Fund? Don't Let the Government Invest.” Social Security Paper No. 6 (14 January). Washington, D.C.: Cato Institute.

Piñera, J. (1996a) “Empowering Workers: The Privatization of Social Security in Chile.” Cato's Letter No. 10. Washington, D.C.: Cato Institute.

Piñera, J. (1996b) Una Propuesta de Reforma del Sistema de Pensiones en España. Madrid: Círculo de Empresarios.

(1997) Report of the 1994-1996 Advisory Council on Social Security. Washington, D.C.: Government Printing Office.

Tanner, M. (1997) “Social Security.” In D. Boaz and E. Crane (eds.) Cato Handbook for Congress. 105th Congress: 245-51. Washington, D.C.: Cato Institute.

Notes

[1] Johnson (1992 [1991]: 783).

[2] James A. Dorn (1996) provides a succinct account of the negative effects of the growth of government on morality.

[3] Stephen Moore (1995: 43).

[4] James Madison, author of the U.S. Constitution, condemned the welfare state on constitutional grounds by saying, “I cannot undertake to lay my finger on that article of the Constitution which grant[s] a right to Congress of expending, on objects of benevolence, the money of their constituents” (Quoted in Dorn 1996: 5).

[5] See Report of the 1994-1996 Advisory Council on Social Security (1997).

[6] Milton Friedman and Rose Friedman (1990 [1980]: 102). The Friedmans also have some fascinating remarks on the jargon of Social Security.

[7] See José Piñera (1996: 1). The lack of property rights in pay-as-you-go social security systems provides a perfect example of the Tragedy of the Commons.

[8] Martin Feldstein (1997: 4) considers that the payroll tax will have to be increased to at least 20 percent in the next 35 years to maintain the currently promised benefits. Michael Tanner (1997: 246) considers that, when other welfare programs such as Medicare are included, payroll taxes will have to increase to as much as 40 percent.

[9] The same actuaries have estimated that under less favorable conditions payroll taxes will have to increase to at least 18 percent and to as much as 23 percent.

[10] Young people save more than old people. By redistributing income from the young to the old, a pay-as-you-go social security system depresses the rate of private savings.

[11] With less disposable income, the opportunity cost of having children increases.

[12] Karl Borden (1995: 3).

[13] The current unfunded liability of the U.S. Social Security system has been estimated at $6 trillion, or about 80 percent of GDP (Ed Crane 1997: 2).

[14] The Social Security Administration has lowered the date of bankruptcy by one year eight times in the last ten years.

[15] Borden (1995: 10-16) provides an overview of recent privatization proposals in the U.S. Congress.

[16] Report of the 1994-1996 Advisory Council on Social Security (1997: 2).

[17] This section follows Piñera (1996a).

[18] This percentage only applies to the first $22,000 of annual income, which means that mandatory savings go down as wages go up.

[19] When the reform was introduced, Chile's capital markets were not well developed and, thus, the reformers felt the need to impose more regulations than one would normally expect in a market-oriented reform. However, the spirit of that reform has been to relax those regulations as the PSA system matures.

[20] See Piñera (1996a: 5).

[21] In essence, the Chilean system is a three-tier system. The first tier is the safety net provided by the government, the second is the mandatory-contributions component and the third is the voluntary-savings component. However, it would be misleading to think that all three components support the system equally; the cornerstone of the system is indeed the mandatory-contributions component.

[22] See Roberto Fuentes (1996: 95).

[23] See Sergio Baeza and Raúl Bürger (1995: 169).

[24] These nations are Peru, Colombia, Argentina, Uruguay, Mexico, El Salvador and Bolivia.

[25] Piñera (1996b) shows that, in the case of Spain, the maximum fiscal cost in excess of the fiscal cost of maintaining the current system would be 0.41 percent of GDP four years after the reform was implemented. Furthermore, only seven years after the reform was implemented, the first fiscal surplus would occur.

[26] See Feldstein (1996).

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