Guest Post: Social Security, and How the Dictator Pinochet Would Have Fixed the American System
Submitted by Gonzalo Lira
Social Security, and the Chilean AFP System
been a lot of talk, lately, from the American political classes, about
“reforming” Social Security. About the need for “tough choices”.
isn’t surprising. Social Security is a demographic and financial
time-bomb. With something like 60 million Baby Boomers about to begin
retiring, the so-called “Social Security lock-box” is going to take
quite the beating—especially considering that that famed “lock-box” is
stuffed not with money but with IOU’s, placed there by the Treasury as
it used the Social Security money to finance deficit spending.
aren’t blind or stupid, even though they do seem to act that way most
of the time. They know that Social Security can’t possibly afford to pay
off what it owes the Baby Boom generation. Politicians of both parties
are making rumbling noises, essentially in two directions: Cutting
benefits, and finding an “alternative system”.
One of those alternative systems some American pundits and politicians have been looking at is the Chilean system of AFP’s—Administradoras de Fondos de Pensiones, literally “Managers of Pension Funds”.
system is a workable free market solution to the problem of funding
worker pensions. Unfortunately for this good idea, the system was
imposed by decree by the dictator Augusto Pinochet back in 1980—so right
there, you have some major political hurdles to overcome. Already one
American politician fried herself irredeemably
by merely mentioning the “P”-word: I’m not sure if it was “Pinochet” or
“privatization” of Social Security that did her in—but one or the other
was to blame. The Chilean AFP system is quite simple: All workers—salaried and independent, state and private—are required to have a Cuenta AFP (individual AFP retirement account). Salaried workers are obliged to pay 10% of their earnings to their Cuenta—their account—up to a ceiling of about $250 per month; a worker can contribute more to their Cuenta beyond that $250 ceiling, but that’s voluntary.
The AFP’s—that is, the companies that actually manage these funds—are
all private: Privately run, and privately held. But they are severely
regulated by the State, by way of the Superintendencia de Pensiones.
They are regulated specifically (and obviously) as to which assets and
investment vehicles the AFP’s can allocate the workers’ monies. The
regulatory relationship is rather aggressively adversarial—deliberately
so, as told to me privately by a former head of the AFP’s watchdog
agency, the aformentioned Superintendencia. This official told me that the bureaucracy assumes
that the AFP’s are all trying to actively cheat the workers—a very
healthy regulatory attitude, as it insures that the actual rate of
corruption remains minimal. What’s more—and crucially—a supervisory
bureaucrat can never go work for one of the AFP’s. So the bureaucrat has
no incentive to cut the AFP’s any slack.
The AFP’s manage the money in the workers’ accounts. Once a worker
retires—at the age that the worker chooses—the AFP turns the worker’s
account into a pension. The younger the worker retires, obviously the
smaller the pension. Workers have insurance policies, in case of a
catastrophic injury or permanent disability, which obliges the AFP to
pay the worker the full pension if they are permanently disabled.
Workers cannot take any money out of their accounts before they
retire—but they are free to move their account from one AFP to another.
Hence AFP’s have the incentive to compete for clients. They therefore
compete on two fronts: Higher returns, and lower administrative costs.
Each AFP pursues its own investment strategy with its clients’ money,
though all of these investment strategies are carefully vetted by the
Superintendencia. The AFP’s offer workers different risk levels for
their accounts. State-imposed age limits make older workers ineligible
Annual returns adjusted for inflation run from about 3.5% to as high as 20%, during good years and depending on the risk of thefondo—but there can also be bad years: At the end of 2008, most of the AFP’s experienced losses—in October of ‘08, the high-risk Fondo A were down about 45%, though the moderate risk Fondo B had dropped 14.25%, and the Fondo D (for those who will retire in 5 years) and Fondo E
(for those about to retire) dropped by 4% and 0.35% respectively. And
note that this was immediately after the Global Financial Crisis. On
average, the AFP’s deliver about 5% to 8% annual returns, above and
The system has been in place since 1980, imposed by the dictatorAugusto Pinochet, and implemented by José Piñera, one of the original Chicago Boys, and the brother of the current president, Sebastián Piñera
(who had nothing to do with the policy; the brothers famously despise
one another, BTW, though publicly they act civil—most of the time).
Pinochet left power in 1990, replaced by a Leftist coalition—La Concertación de Partidos por la Democracia—but
in twenty years of power and four different Left and Center-Left
presidents, the Concertación tinkered with the system a bit, but they
never really touched it.
They wouldn’t have dared. There would have been hell to pay if they had—‘cause the AFP system works.
The AFP system not only changed the way people retire—it changed the
Chilean people’s views on capitalism. Simply put, I would argue that
with the AFP system, every Chilean worker became an instant and fervent
capitalist, regardless of their supposed political beliefs.
Historically, Chile was an agricultural country. So the workers on thefundos—farms
and ranches—received cradle-to-grave care in an informal system that
was similar to a serf system. With industrialization, this sistema patronal was translated from the fields to the factory floor.
However, the pensions promised to the industrial factory workers were
not always paid. Small companies might simply go bankrupt, medium-sized
companies might cheat the workers, and large companies might simply
ignore the workers.
The State was able to createcajas previsionales—effectively
retirement savings accounts—but these did not invest in financial
assets: They were strictly savings accounts, and so naturally, inflation
had its way with these monies in due time.
Throughout the XX century, efforts were made to ameliorate the effects
of the transition from an agricultural to an industrial economy, to
little avail. In reaction to this failure, Socialism and Communism arose
to defend workers’ rights, one of which was the right to a fair
Most people depended on a company pension for their retirement—with all
the uncertainty that that entails. Company pensions also maintained the
patronal or serf mentality. People—workers—felt bound to the company:
They did not feel free to work for a company, then change jobs, since
they would then lose their seniority, which of course would affect their
So in a real sense, the XX century Chilean industrial economy was no
different from the XVIII century Chilean rural economy, with regards
workers and their employers—the only real difference was, farm workers
had land, and food, and shelter. Industrial workers had none of that
basic security—just the promise of a pension.
When the Allende regime won the election of 1970, and began imposing its
Maoist-Leninist repressive and terrorist regime—because that’s what it
was, repressive and terrorist, regardless of what its defenders might
pretend—the situation came to a head. The Allende regime deliberately
fomented worker unrest, using the threat of violent worker revolt to
goad the different sectors of Chilean society—not just the oligarchs,
but the military, the landed aristocracy, the foreign and domestic
miners, the civil service, students (college and high-schoolers), etc.
It must be understoodas I have defined fascism and corporatism previously, Chile was a fascist-corporatist country long before Pinochet.
Chile—long before the 1973 coup—was a syndicalist-corporatist country of
competing union, social and corporate interests, where the State was
one more competing interest among many.
This situation was what led to the near-civil war in September, 1973.
Allende—in his urge to have the State (and his person) be the ultimate
(“plantation owner”)—essentially set the different interests groups of
the country on a collision course. He radicalized the workers, played on
the middle-class’ sense of economic uncertainty and social
stratification, and tried to bring a crack in Chilean society where he
could implement his Maoist-Leninist Socialist State. (This isn’t
controversial—Allende said so himself in all his speeches.)
In this fascist-corporatist state which was Chile before Pinochet, the
individual citizen was merely a cog within one of the corporate
entitites or another to which he or she belonged—so naturally, the
individual citizen allied himself with one of the competing interests in
Chilean society, be it company or Party or union or class, in
opposition to some other, competing interest from one of the other
sectors of society. In other words, Chilean society was delineated like a
Pinochet—I believe deliberately—changed that. The more I study his
policies, the more convinced I am that that was his conscious goal: To
end the corporatist-syndicalist, competing-interest-group mentality that
stratified and isolated different social groups in Chile, and which
made the country a collection of competing and self-defeating little
cliques, to the detriment of the country as a whole.
Whether I’m right or not on this specific issue is beside the point.
What I can here say unequivocably is that, so far as the AFP system he
forcibly imposed is concerned, it changed Chilean society
By imposing the AFP system in 1980, workers became free to move from job
to job, and not be bound to any one company because of fear of losing
their pension. Hence it gave the opportunity for real middle-class
mobility. (Though Chile had always had a fairly large middle-class when
compared to the rest of Latin America, it was stagnant, and bitterly
divided by issues of social class: The inordinate social stratification
of Chilean society makes the British class system look positively
egalitarian in comparison. And much of this social-class bitterness
expressed itself politically—with terrible consequences.)
By creating the AFP’s, and making them invest the money of the workers,
the Chilean economy suddenly had a lot more home-grown capital chasing
returns—so there was more local investment in small to medium-sized
firms. Most of the wine and salmon industry in Chile was financed this
By freeing companies from the obligation of pensions—from the very idea
of pensions—companies could behave like companies, and not like pension
funds—or worse, like
In other words, a company’s financial health of today and tomorrow is
not affected by unwise but binding promises made twenty or thirty years
ago. Look at GM, loaded with all those promises made to UAW workers—no
Chilean company has such a burden.
also shuts out the State from managing money—which is something
devoutly to be wished. A State with excess cash is a State which will spend that
cash—the famed Social Security “lock-box” is a case in point: The money
American citizens have contributed to the system is not parked there,
carefully earning interest. It’s gone—spent
on foolish wars and monstrous health care plans. By keeping this money
away from the State, the AFP system reduces the State’s temptation to
simply throw money at problems, and instead actually solve them.
Finally, a subtle but exceedingly important effect of the AFP system,
which I mentioned before briefly, is that it makes everyone a
capitalist. I actually think it’s the most important of all of the
effects of the system. In Chile, everyone follows their
as closely as the soccer league. Closer, even: You get a statement in
the mail every month, telling you how much you added this month, how
much your nest-egg is now worth, and how much you would receive were you
to retire right now, or continue to add to your Cuenta
until 65. It’s a heady feeling, and it makes Chilean society very
protective of private corporations and companies. Strikes happen, but
far fewer—usually for genuine financial reasons, not for random
political reasons, as used to be the case. And unlike before 1973,
striking workers don’t destroy machinery or other assets. It has become
politically unpopular—not to say anathema—to disrupt the economy for the
sake of making a political statement. People measure work stoppages of
any sort by how much the overall economy lost—because that is now the
measure of how much an individual’s Cuenta
has lost. People actually bitched about the February earthquake in
terms of damage to the economy, and how lucky Chile was that it happened
at the start of a weekend, instead of in the middle of a work-week—I’m
In other words, with the AFP system, every citizen feels he or she has
skin in the game, so far as the overall economy is concerned. This is an
extremely significant effect of the system—I believe the most
significant—as it points the way for other developing nations, and how
they should organize their domestic economic life, in order to achieve
stability and progress under a Capitalist regime.
Now, the AFP system isn’t without flaws. Critics in Chile tend to focus
on two aspects: The dwindling of the AFP’s down to half a dozen
companies, and the possible oligopolistic tendencies that that might
entail; and the lack of “democratic representation” on the boards of
directors of the AFP’s.
as the first criticism is concerned, from an original 12 that began in
1980, the number of AFP’s grew to 22 by 1994. Through buy-outs and
consolidations, there are now 6. The largest, Provida, has 43% of the
market as measured by assets-under-management, the second, Habitat, 24%,
the remaining four fractions thereof. But none of the six have acted
oligopolistically, and all are tightly regulated. Indeed, all of their
mergers occurred under Left-leaning regulators. And to top it off,
market share does tend to swing wildly, as customers vote with their
feet—after all, they can move their account to a better, higher yielding
AFP whenever they want. So in my opinion, the first criticism is a
possibility to be prevented, but not a near-term possibility that might
second “criticism” is really a complaint by Union officials and the
professional Left, who are marginalized from participation in this
virulently Capitalist scheme because of their own views. The same people
and parties who want more “democratic” representation on the boards of
the AFP’s are the same people and parties who regularly call for the end
of the AFP system altogether. Their “criticism” can’t be taken
My own criticism goes in another direction: As a Chilean, I object to the fact that workers’Cuentas
diminish during bad years, such as 2008, whereas in good years, the
AFP’s enormous profits—albeit well-deserved—remain in their coffers. In
other words, I think there ought to be a High-Tide Mark: If the
diminish during a bad year, then the AFP ought to go into its back
profits and “top-off” the workers’ accounts. Call it socialism, call it
what-you-will: It doesn’t seem fair to me that the AFP—earning good
money off of managing its customers’ monies, which they are legally
bound to deposit with the AFP’s—should not share the pain when times are
tough. The AFP’s have the privilege of receiving citizens’ monies by
order of the State—they ought to share the pain when things go south.
(This is a similar objection that many people have to hedge funds—and
which is why I'd never buy into one.)
These criticisms aside, since Pinochet left in 1990, there haven’t been
any serious, structural changes to the basic system. Independent workers
and the poor have been encouraged to join, and a few cosmetic changes
have been implemented—but basically, it’s worked like a charm.
How does this Chilean pension fund system help the U.S.? Well, in a word, it doesn’t.
Chile is a historically poor country—hence Chileans are aware that the
State cannot provide everything. Manipulating the private sector into a
course of action which creates a public good—such as the AFP system,
such as the ISAPRE (health care) system—yet at the same time creates a
profit (and therefore an incentive) for the private sector, is something
that Chileans have gotten into only recently; really since Pinochet
starting in ’73. But boy has it caught on!
The average American citizen, on the other hand, has gone in the
opposite direction. American citizens fully believe that the U.S.
Government can do it all—fight all the wars, pay all the bills, in
short, “do what’s right”, etc. In other words, Americans believe in a
Mommy State—the Great American Teat. It should come as no surprise,
then, how willingly Americans allow their basic civil rights and
liberties to be trampled by the Government—attitudes such as those
exhibited by American politicians and leaders would be cause for outrage
in Chile. But American citizens are as docile as sheep—except when it
comes to what they believe is coming to them.
Every American believes they are owed Social Security. What was once a
stop-gap, temporary measure adopted by Roosevelt at the height of the
Depression, which could be easily financed with 30 workers to every
retiree, is now a monster-spending program—it has gone off the rails.
According to George W. Bush’s
in 1950, the ratio of workers to retirees was 16 to 1. At the time of
his speech, it was 3.3 to 1. And by the time the Baby Boomers retire, he
said it would be 2 to 1. He
said it—George-fucking-dubya-fucking-Bush in a State of the Union
speech. Not exactly Noam Chomsky at a Bennington College coffee klatsch.
The Social Security shortfall is inevitable—but American citizens are
unwilling to sensibly change their pension system. They lack the
political will to do it for themselves, and there is no dictator—such as
Pinochet—to force the country to do it.
Therefore, the outlook is inevitable: Social Security will either be cut, or taxes will rise to pay for it.
I believe shrewd policy makers are hoping that inflation helps the cause and gives Social Security beneficiaries ade facto haircut. These policy makers—Bernanke, Geitner, Summers—seem to believe that inflation is the only way to stave off The Deficit, which of course includes Social Security. But as I have argued, I do not believe you can have “controlled” inflation—and as I have further argued, once the Fed’s “asset purchases” (id est,
money printing) reaches a certain tipping point, nearly-flat Treasury
yields will reverse and skyrocket, as people lose faith in U.S.
sovereign debt, and this will trigger hyperinflation.
If there is hyperinflation—as I believe there will be—then Social
Security recipients would be the first to clamor for an “adjustment”.
Call it the Mother of all
Karl Marx said it best: A democracy will fail when the people realize
that they control the purse strings. In America, in short order, there
will be more retirees—who will be politically better organized—than the
rest of the population. Therefore, taxes will skyrocket, to pay for
these people who didn’t plan for their own retirement. What would be the
effects of way higher taxes in a stagnant economy? You fill in the