The pension crisis

THE PRIVATISATION of the pension fund system in Latin America was hailed as one of the most important developments of the 1990s. A major challenge for developing countries is the lack of local savings. By definition, developing countries are in transition. They need a great deal of capital to modernise their infrastructure and improve their workforce through better education and health systems. This left most countries highly dependent on international capital flows. The problem is that international capital flows are highly volatile. They are dependent on external political and economic cycles. The sudden starts and stops of the international financial markets have only added to the fragility of the region. The privatisation of the pension fund system was supposed to reduce this dependency and fragility. Moreover, it was supposed to improve the fiscal viability of the developing world by reducing or eliminating the need for the state to be the provider of pension benefits. State pensions are relatively old. Originally, they were associated with the military. Aerarium militare were benefits that were awarded to Roman military veterans. Scottish Widows is an asset manager which was started in Edinburgh after the Napoleonic Wars as a provider of benefits for fallen soldiers. Veterans of the United States Continental Army were also awarded pensions after independence. However, it was the expansion of the Industrial Revolution and the rise of labour unions during the 19th century that resulted in the creation of public pension plans. The problem was that most of the systems were pay-as-you-go. This meant that, while the state collected taxes to pay for the benefits, there was no accumulation of assets. The funds came out of the current budget. As populations grew, mortality rates improved and the range of benefits expanded, the fiscal burden became daunting. Today, Brazil’s state pensions represent 44 per cent of the federal budget, thus crowding out the government’s ability to provide other services, such as health, education, infrastructure, defence and security. Governments needed to ease this burden, and privatisation seemed to be the solution. Private pension funds could also become an important source of local capital, thus providing much-needed investment. This is why there was so much enthusiasm for the reforms, but there were flaws. One of the structural problems with emerging market economies is the high level of informality. In an effort to improve labour flexibility and reduce labour costs, employers often hire people informally. This means that there are no labour contracts, thus avoiding payroll taxes, the costs associated with benefits, and the potential liability of indemnification. Many emerging

market labourers are also selfemployed, either as day labourers or service providers—such as maids, drivers, food stall owners, etc. The problem is that these types of workers typically cannot participate in the privatised pension systems. Some countries have introduced reforms to allow them to join, but most of them do not. As a result, a large part of the workforce and population remains outside the pension fund system. An OECD study found that 48.3 per cent of the nonagricultural workforce in Latin America, during 20102014, was informal. Therefore, while the privatisation of the pension system seemed to be a good idea, it was not fulfilling its intended objective. The lack of benefits for a large part of the population became a political problem. The income gap widened tremendously. Hence, governments were forced to provide pensions for the individuals who remained outside the system, thus eliminating the benefits of the reform. At the same time, the private companies that operated the funds reaped enormous management fees for doing almost nothing. The funds’ performances were publicly available, and competitors mimicked each other’s portfolio in order not to provide variance in outcomes. One by one, the various pension fund systems have come under attack. In 2008, Argentina nationalised US$30 billion in private pension funds. Last year’s riots in Chile were partly attributed to a pension scheme that benefited a few. There are rumblings in Colombia and Peru about the need to modify their private pension systems. The reform that was supposed to lead to significant improvements has fallen short of the mark, and it has led to a serious crisis.