Tag Archives: Welfare State

Case Study: Chile’s Private Social Security

                                                          Above: Running ‘Cause I Can’t Fly

It’s no secret that the United States’ brand of old-age safety net, known as “Social Security” is aging and failing. Due to the changing demographic nature of the U.S. labor force and the American people as a whole, the program is headed for collapse and insolvency. While the exact date of this collapse is hotly disputed, its inevitability is not. Given this situation, solutions are desperately needed and free-market proponents are stepping up to the plate to offer help.            Reformers commonly reference Chile’s privatization of its old-age pension program as a source of inspiration for changes to Social Security. Under the current setup of Social Security, the pensions of retirees are paid for by current workers. Thanks to increased life expectancies, declining fertility rates, and the en masse retirement of baby boomers, the ratio of workers not collecting social security to the number of pensioners receiving benefits continues its steady decline. In addition to retirees aged 64+, approximately 1 million permanently disabled individuals receive social security payments along with spouses and children of disabled or deceased workers.                                                                                                                                                    In 1924, Chile was the first Western hemisphere country to introduce a social insurance scheme that covered retired workers, their survivors, and disabled persons. By 1980, the Pinochet military junta was faced with the failure of this pay-as-you-go (PAYGO) pension system. Taking inspiration from Milton Friedman, Pinochet and his team of “Chicago Boys” transformed Chile’s pension system into the capitalist wonder that it is today.                                                                  In the old system, there were three major branches of the system: one for government workers, one for salaried employees, and one for manual workers. In addition, there were more than 30 other funds for workers in various professions. Each fund had its own particular administrative bureaucracy and set of rules. Some retirees were even allowed to draw from multiple funds. The system also guaranteed a minimum pension to each worker, irrespective of previous contributions or earnings. On top of all that, a worker’s pension payments were calculated based on the earnings from his final 5 years of work, prompting many to under-report their income (and, thus, contribute less to the fund) until those final five years.                                                                                                                           Above: Augusto Pinochet Ugarte

Europeans take note; efforts throughout the 1970’s to prolong the expiration date of this system such as raising the retirement age and limiting pension adjustments to less than the rate of inflation, did little to assuage the nation’s economic crisis. The new system, begun in 1980 operates on the principle of choice by giving workers options at all stages of the process.           Under the current Chilean model, a worker chooses which private AFPs (Administradoras de fondos de pensiones) he wants to manage his individual “nest egg” account that will fund his pensions later in life. Each worker may have only one such account with one AFP. Each worker is required to contribute 10% of his monthly earnings to the account. This mandatory contribution is tax-exempt while any additional contributions, which are permitted up to a predetermined amount of money tied to the CPI, are taxed. Participation in the system is completely optional for self-employed workers.                                                                                                                                   If the worker so desires, he may set up additional savings accounts with the same AFP. Workers may make up to four withdrawals from these accounts per year and may draw from these accounts as well as from the primary account to finance retirement. Since the government does not officially recognize these accounts as retirement contributions, the money is subject to income tax.                                                                                                                           A worker may retire early if his account has the funds to support a pension that equals at least 50% of his average annual indexed wage over the previous 10 years and at least 110% of the government’s minimum old-age pension. If a worker retires at the normal retirement age (65 for men and 60 for women), he can choose to make scheduled withdrawals from his account, purchase an annuity, or form some combination of the two. Whatever he decides, his pension payments will be subject to income tax.                                                                                                                                                                                                                                                                                                                                                               The privately-operated AFPs, are setup to manage a single pension fund comprised of a collection of workers’ accounts. Any organization of shareholders may form an AFP except banks.  AFPs are bound by stringent regulations and expectations. Originally permitted to invest only in low-risk domestic ventures (e.g. government bonds, time deposits, etc.), AFPs may invest in various international ventures, private stocks, company bonds, mortgage loans, and more.             Pension funds are obligated to maintain a ROI (rate of return on investment) between maximum and minimum ROI rates tied to the average 12-month return for all pension funds. In order to protect individuals’ retirement accounts, pensions funds are required to abide by a 1% investment ratio, whereby 1% of the fund’s value is held in the form of reserves.                                     Should the ROI of a pension fund exceed the average ROI of all pension funds by 2 percentage points or 50%, whichever is greater, the excess profit must be transferred to a profitability reserve. If the ROI of a pension fund falls below the average ROI of all pension fund by 2 percentage points or 50%, whichever is lesser, funds from the investment or profitability reserves must be transferred to the pension fund to make up the difference.                                           If an AFP with a below-average ROI fails to make up the difference within 6 months, the government takes control of the AFP, pays the pension fund, and then assigns the accounts to other AFPs. Of course, the individual owners of the accounts may choose to which AFP they want to move their account.                                                                                                                                                                         Above: Profitability of Chilean AFPs vs. banks

There is a provision to protect people in the unlikely event that their privately-managed retirement funds don’t pan out when it’s time to retire. The government steps in and pays a retiree a minimum pension if the individual is of retirement age or older, has paid contributions for at least 20 years and either exhausts his retirement savings or whose accrued savings can’t support the minimum pension payments as set by law.                                                                               As far as the effectiveness of the Chilean model, the proof is in the pudding. According to the OECD, the average real ROI for private Chilean pension funds was 6.1% between 2000 and 2005 while it was 1.5% in the United States. By 2005, Chile’s pension fund assets, the money available to pay out to pensioners, was equal to 59% of the value of GDP, a figure well above the average of 15% for Latin America. That statistic is a testament to the wisdom of the Chilean reforms for two reasons: 1) it demonstrates a remarkable turnaround for a retirement system that was nearly bankrupt only 25 years prior and 2) the figure is comparable to those of more advanced economies such as Canada(60%) and the Australia (69%). If you trust the figures from Chile’s Superintendency of Pensions, this success is generally pretty evenly spread among the various pensions fund.                                                                                                                                                           While Chile’s system is far from perfect, as evidenced by its severely fluctuating ROI rates from year to year and the need for reforms in 2008, it’s private model certainly has turned things around. The U.S would be wise to learn from, not duplicate, the Chilean model by implementing more of the personal choice and private oversight of pensions that has worked so well for Chile.

New Deal or Raw Deal?

                                                                                                       Franklin Roosevelt’s New Deal is, perhaps, the greatest single dupe ever foisted on the American people. According to the revisionist narrative, the era represented a vindication of the progressive messianic complex. If modern revisionists are to be believed, the New Deal rescued an America reeling from an economic disaster caused by a clueless and non-interventionist government and fundamentally re-structured the American economy all while achieving fundamental and long-lasting reforms in social welfare and justice that have benefited ensuing generations of Americans. As you might have guessed from reading this blog, I don’t subscribe to a revisionist line of thinking.                                                                                                                          In my view, the New Deal represents a unilateral roll-out of the progressive agenda on the American people and the hijacking of the Democratic Party as a means of implementing this agenda. Not only did the federal government undergo a massive expansion in size and scope but it was achieved through egregious transgression of the constitutional process. If anything is to be learned from this chapter in American history it is, in the words of Benjamin Franklin:

“Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety.”

One of the earlier attacks on the personal freedoms of American citizens came in 1933 with FDR’s Executive Order 6102. The directive, made the hoarding of monetary gold by any person or organization criminal. The order required all in possession of gold to return said gold to Federal Reserve Bank in exchange for a set amount of paper currency per ounce. Not only did this law set a dangerous precedent that normalizes and encourages economic collectivization by the federal government but it was done in the name of economic necessity. Proponents argued that in order for the Federal Reserve needed to increase its gold reserves in order to maintain the reserve ratios it had set for itself. Following the order American citizens were subjected to federal raids and seizures of gold exceeding the allowable limit. Not only were American individuals and businesses deprived of their property but foreign companies too. It wasn’t until 1974, nearly 41 years later, that the private ownership and trade of gold was once again fully legalized.

     The economic freedoms of private businesses and citizens were further infringed with the passage of the Agricultural Adjustment Act (1938) and the decision in Wickard v. Filburn (1942). The Agricultural Adjustment Act granted the Agricultural Adjustment Agency the power to regulate the private production of wheat, cotton, corn, hogs, rice, tobacco, and milk. In future amendments to the law, the list was expanded to include rye, flax, barley, grain, sorghum, cattle, peanuts, sugarbeets, sugarcane, and potatoes. The federal government chose to regulate these specific products because they were deemed to be in overproduction. According to the New Deal proponents, regulation (i.e “destruction”) of crop surpluses grown privately was essential for a full and complete economic recovery.                                                                             The controversy surrounding this legislation finally came to a head in the 1942 supreme court case, Wickard v. Filburn. The defendant, Roscoe Filburn, was an Ohio wheat farmer who grew wheat in excess of the limits set forth by the government. The excess wheat was grown purely for subsistence, that is, personal consumption not for sale. In court, Filburn argued that the Agricultural Adjustment Act didn’t apply to his surplus of wheat because it didn’t fall under the domain of commerce which the federal government was given the power to regulate under the Interstate Commerce Clause of the U.S Constitution. Against previous rulings by lower courts, the Supreme Court ruled that the surplus did fall under the category of “commerce” because growing wheat for personal use affected the amount of wheat that would be bought for chicken feed! This ridiculous ruling not only defies basic economic sense (the price of chicken will be higher if Filburn has to buy other people’s wheat) but set a dangerous precedent for the interpretation of the Commerce Clause (Art. 1, Sect. 8, Clause 3) in future supreme court cases.

                                                             The failed Judicial Procedures Reform Bill of 1937 was another constitutional near-disaster. Had the bill passed, the office of the president would have expanded its powers on Caesarean proportions. Had it passed, the bill would have allowed the president to appoint a new supreme court justice whenever a sitting justice reached the age of seventy. The legislation allowed for up to 6 justices sitting on the same court to be appointed in this manner. The impetus behind this conspiracy, which was so see-through that it became known as the “court-packing scheme,” was Roosevelt’s desire to create a court that favored his legislation. Publicly, this motivation was presented as a measure to ensure that no one party ever controlled too many branches of the federal government, never mind the will of the people.                                                                                 With the creation of highly-publicized social assistance programs the New Deal heralded a new era of dependency on government. The New Deal certainly laid the foundations for an American welfare state whose complete construction is being debated to this day. The creation of Social Security in 1935 saddled generations of American taxpayers with deficits and anxiety over the impending insolvency of this huge social “safety net.”                                                                    In 1935, under the Social Security Act, the Aid to Families with Dependent Children (AFDC) was  established. The program was a precursor to the modern-day Temporary Assistance for Needy Families (TANF) better known as welfare. The AFDC was and, in some circles, is considered radical for its direct financial support of single, unemployed, and unwed mothers. Research conducted in previous decades, most notably the Moynihan Report, found that programs such as the AFDC encouraged out-of-wedlock births and the general disintegration of the working-class family unit.  It wasn’t until 1996 that the AFDC was reformed with the passage of the Personal Responsibility and Work Opportunity Reconciliation Act.

                                                     The National Housing Acts of 1934 and 1937 laid the foundations for the large-scale construction of public housing projects and redlining practices that promoted inner city decay and racial segregation that dominated the middle part of the 20th century. To be fair, the legislation did create the Federal Savings and Loan Insurance Corporation, which insured deposits in savings and loan institutions until it was consolidated with the FDIC in 1989. However, the creation of the United States Housing Authority ushered in a new era of large-scale public housing projects that concentrated and magnified the miseries of the urban poor. To build these housing projects, neighborhoods were razed, stripping residents and businessmen of their land ownership in the process.                                                                                    The Federal Housing Administration only magnified these problems with their racist redlining and blacklisting tactics whereby neighborhoods were evaluated for the relative “stability” of lending to and insuring residents, often based on a locale’s racial demographics. As a result, banks and insurance companies refused to do business in certain neighborhoods, stifling many of the otherwise upwardly-bound poor.                                                                                                          There are too many pieces of the New Deal to examine fully and satisfactorily in one post. One thing is clear; the New Deal has left our nation with a legacy that we are still grappling with and will continue to grapple with for some time.