Social Security Reform
Privatizing Social Security in Latin America
A Conversation with Indermit Gill of the World Bank / News Release
December 9, 2004
AARP Global Aging Program Idea Exchange Series
Washington, D.C.
The views expressed in these proceedings are those of Mr. Indermit Gill and do not necessarily represent the views of the World Bank or AARP.
On Thursday, December 9, 2004 Indermit Gill from the World Bank came to AARP’s Global Aging Program Idea Exchange to discuss key findings from his new book, Keeping the Promise of Social Security in Latin America, published recently by Stanford University Press, and co-authored with Truman Packard, Juan Yermo, and Todd Pugatch.
Mr. Gill began by stating that he would not be talking about social security reforms in the US, about which he knew very little. He said his talk would be about the experience of countries in Latin America over the last two decades. He began by sharing a history of the book, which was several years in making. In it, he and his co-authors explain some of the lessons learned on social security reform in Latin America. To motivate the discussion, he presented three propositions:
- The Latin American reforms were often driven by short-term concerns, but have had important long-term (positive and negative) effects
- The reforms were often driven by a loss of faith in government, not always by a serious reflection of its role in development, but the role of government remains important.
- The reforms were often driven by narrow interests, not by a broad consensus on social security, but it is increasingly clear that a consensus is necessary for the sustainability of the reforms.
The reforms examined in the book were "structural" ones that occurred in 12 countries in Latin America over the past two decades. The notable countries excluded from the study are Brazil and Venezuela, which did not undertake reforms that could be classified as "structural". The 12 countries adopted, or are in the process of adopting, a similar model, which included phasing out the pay-as-you-go (PAYGO) system, instituting a second pillar for private management of mandatory pensions, and the introduction of incentives for voluntary retirement savings. The reforms have attracted the attention of policymakers in other parts of the world. Some variant of this general approach was either implemented or considered in some Eastern European and Central Asian countries and even the United States considered some elements of the reforms in 2001 and will, most likely, consider them again in 2005.
Of all the components, the defining characteristic of the Latin American reforms is the privately managed second tier. When the reforms came about, participation in the privately managed tier was not always mandatory; later reforms tend to make it more so so, according to Mr. Gill. Highlights of each pillar or tier are laid out in the following chart:
| Nature of Instrument | Mainstay: Pooling | Mainstay: Saving | Mainstay: Saving |
| Mandatory | Mandatory | Voluntary | |
| Common Name | First Pillar | Second Pillar | Third Pillar |
| Main function | Insure against poverty in old age, lower income inequality | Smooth consumption over life cycle | Smooth consumption overlife cycle |
| Main role of government | Defines benefits | Defines contributions | Defines incentives |
| Principal risk-bearer | Government | Worker | Worker |
| Financial instrument | Unfunded PAYG | Funded: individual accounts | Funded: taxpreferred individual accounts |
Although the changes are significant in each country, they have not always reduced the level of government involvement in the social security systems. In fact, according to Mr. Gill, all but two of the countries increased payroll taxes, creating even more government involvement in the labor market.
Other research has found in the Latin American models is that ministries of finance have often been proponents of the reforms. However, social ministries have sometimes resisted change. Banking and finance groups are champions of the Latin American type-reforms, according to Mr. Gill, and foreign investors tend to reward these reforms.
When assessed against their objectives, the Latin American reforms, according to Mr. Gill, present a mixed picture. His presentation and book share the following main assessments:
- The move towards greater individualization of social security is appropriate given demographic changes in the region.
- System deficits have decreased and the build-up of implicit pension debt has slowed, but the strain of transition costs and making debt explicit may have compromised fiscal stability in some countries.
- Dedicated pension providers help deepen capital markets, but pose a regulatory challenge as evidenced in high fees.
- Within-system equity improves, but there are little or no gains in coverage, so overall equity gains are small.
The reforms reduced buildup of governments’ implicit pension debt and reduced implicit transfers from poor to richer workers. However, according to Mr. Gill, 2/3rds of the median country’s fund portfolio consists of government bonds. Payroll taxes generally rise to finance the transition and costs to workers can be high, sometimes with higher charges for lower wage (younger and poorer) workers, while coverage remains stalled. Between a tenth to two-thirds of the aged in Latin America get such pensions today.
The low take-up by workers may not be due to myopia, nor a lack of information, but according to Mr. Gill, may be a matter of rational choice. There are high mandatory contributions in Latin American countries, with the payroll taxes higher in all countries, except for Chile, after reforms. There are also high costs that are evident in countries such as Peru. The reforms could also contribute to macroeconomic destabilization through their transition costs which can be hard to assess accurately, as in Bolivia; these can reduce employment and wage growth and the capacity of workers to contribute.
To conclude, the main achievement of the reforms is the individualization of old age income security; Mr. Gill argued that the changes were appropriate given the demographic changes. However, the importance and extent of privatization may have been exaggerated, because governments have not reduced their presence: the funds are largely held in government bonds, so pensioners still depend on governments’ promises to pay. While the reforms are an improvement on what existed before them, the main evidence of remaining weaknesses in the Latin American reform model is stalled participation. Coverage rates have not gone up and poverty prevention tiers—which are likely to be the avenue through which participation can be increased—have not always received the attention they deserve.