Should we privatize social security?

Those running the Social Security System aren’t quite off the hook, even as President Aquino’s veto of the proposed law to raise SSS retiree pensions by P2,000 was justified based on long-term considerations. There has to be something wrong when the agency can only collect little more than a third of potential contributions; when the Commission on Audit calls its management to task for keeping P18 billion in assets idle in 2014, foregoing nearly P200 million in potential earnings; when the same COA orders the return of nearly P72 million in unauthorized management bonuses to the government and… the list goes on.

Is the SSS yet another example of something the private sector could do better? Should social security be privatized, as has become an appealing idea among free market advocates, who point to Chile’s 34-year experience with privatized social security as a model? Let’s examine the pros and cons.

One must first understand the fundamental difference between the traditional “pay as you go” system and the privatized one. In the former, contributions by today’s workers and employers fund the benefits paid out in the form of pensions of retirees, along with salary loans and sickness, disability and death benefits for members. When today’s workers retire, their pensions will in turn come from contributions paid by future workers. As such, there is no direct relationship between what a worker pays into the system and what he/she gets out of it. But benefits, subject to certain conditions, are guaranteed to all eligible members. Thus, government-administered social security is also called a “defined benefit” system.

The privatized approach, in contrast, is a “defined contribution” system, where the worker keeps ownership of the money he/she pays, which accumulates in a personal saving/investment account managed by a private investment manager. The benefits are directly tied to contributions. The more one puts in, the more benefits one can get, which are determined by the earnings of the savings fund the worker accumulates over the years through his/her contributions (actually, deposits).

Adherents of the privatized scheme point to much higher rates of return workers’ savings could have earned in private capital markets, compared to those historically earned in government-handled social security funds. In the United States, it is pointed out that investments in private capital markets earned an 11.5-percent average return on investments in past decades, whereas retirees as of 2014 effectively earned only 2.7- to 3.9-percent return on their contributions. Furthermore, the privatized scheme could boost economic growth due to the reduced tax burden and higher personal savings and investment generated. Since Chile privatized its pension system in 1981, retirement savings accounts have generated an estimated equivalent of 50 percent of the country’s gross domestic product, and annual GDP growth doubled to more than 7 percent.

Fifteen years hence, Jose Piñera, the Chilean labor and social security secretary who introduced the scheme, made this assessment: “The Chilean worker is an owner, a capitalist. There is no more powerful way to stabilize a free-market economy and to get the support of the workers than to link them directly to the benefits of the market system. When Chile grows at 7 percent or when the stock market doubles… workers benefit directly, not only through high wages, not only through more employment, but through additional capital in their individual pension accounts.”

It’s not all that rosy, however. Workers can lose their money if the markets collapse. Moreover, privatization will not make the problem of an imminently bankrupt SSS go away. The fiscal burden on the government will in fact get worse if contributions are henceforth channeled into individual retirement accounts, rather than add to the SSS trust fund. The funding source for current and future benefits will shrink, forcing taxpayers to shoulder the huge burden under the transition that will take a generation to complete—and it turns out, even beyond.

In 2006, Nobel laureate Paul Krugman observed: “…the Chilean system… has yet to deliver on its promise to reduce government spending. More than 20 years (later), the government is still pouring in money…. Privatization would have condemned many retirees to dire poverty, and the government stepped back in to save them.” Even market advocate Sebastian Piñera, brother of the scheme’s sponsor, who ran and lost against current President Michelle Bachelet, lamented that “half of Chileans have no pension coverage, and of those who do, 40 percent are going to find it hard to reach the minimum level.”

Meanwhile, a New York Times report noted: “… Chile’s pension funds, whose number has shrunk to 6 from more than 20 as competition has diminished, recorded an average annual profitability of more than 50 percent during a recent five-year period. Other studies, including one by the World Bank, indicate that pension funds retain between a quarter and a third of workers’ contributions in the form of commissions, insurance and other administrative fees.” Privatization skeptics don’t relish the prospect of further enriching finance industry players who understandably are among the strongest advocates of the scheme—all at the expense of common workers.

Is privatized social security for us? There are compelling arguments on both sides of the question, well beyond what space allows me to expound here, and the issue certainly calls for national debate. But privatize or not, those running the SSS have a lot of shaping up to do under the system we have now.

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