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Introduction
In 1980, the Chilean pension system was in crisis. It was paying more in benefits than it was receiving in contributions, and the projected actuarial imbalance was greater than the country's Gross Domestic Product (GDP).1 The prescribed solution was to radically transform the traditional pay-as-you-go structure to a system based on personal retirement accounts. Box 1 (See PDF) describes the main features of the current Chilean system. Nearly 25 years after the reform, it is possible to assess the Chilean experience.
The good
The pension reform replaced the old pay-as-you-go-system with one pre-funded with personal retirement accounts. The Chilean experience illustrates that, when needed, extreme and fiscally sound pension reforms can bring dynamism to the capital markets.
Enormous problems justify complete restructuring
The traditional Chilean system was chaotic and vulnerable to political pressures. The 'system' was nothing more than a collection of more than 100 different pension regimes. Each regime had special rules, demanded different levels of contributions and promised different benefits, tailored to satisfy special interest groups. In some cases, white-collar workers could comfortably retire in their 40s, while blue-collar workers had to wait until their 60s to qualify for minimum retirement benefits. The contribution rate reached levels that discouraged participation and compliance. In the mid-1970s, for example, average contribution rates surpassed 20 per cent of taxable wages. The system was poorly administered and inefficient. 5, 6, 7
The chaotic structure of the system was accompanied by growing deficits. Severe inflation and poor management depleted potentially large reserve accumulations. By the late 1970s, the Chilean system experienced annual deficits of nearly 3 per cent of GDP, and these deficits were projected to increase rapidly to more than 20 per cent by 2000. 8, 9
Improving the traditional pension structure did not seem like a viable option, either politically or financially. Small patches would have increased the complexity of the system. The Chilean system faced enormous problems that demanded (and justified) radical changes that replaced the traditional -- and increasingly unfair -- system with one based on private retirement accounts.
Paying for the transition
Radical changes in retirement systems are likely to require large levels of funding to finance the transition. Contributions to private retirement accounts reduce the revenues available to pay...