DATE: Monday, August 25, 1997               TAG: 9708220034

SECTION: LOCAL                   PAGE: B8   EDITION: FINAL 

TYPE: OPINION 

SOURCE: BY JOSE PINERA 

                                            LENGTH:   91 lines

HOW WE PRIVATIZED SOCIAL SECURITY IN CHILE

Social Security is the single largest government program in the United States, spending $350 billion a year - more than the defense budget during the Cold War.

The bad news is that Social Security is approaching bankruptcy. It won't be able to pay all the benefits everybody has been promised. This is because any pay-as-you-go social security system has a structural flaw: It destroys the link between work and reward, personal responsibilities and personal rights.

The good news is that there is an alternative that works. It was developed in Chile where a pay-as-you-go social security system had been started in 1925, more than a decade before it was enacted in the United States. Instead of paying a payroll tax, every Chilean worker sends his monthly contribution - between 10 percent and 20 percent of wages - to a tax-deferred pension savings account. These contributions are invested in capital markets through private investment managers, yielding real positive rates of return.

If you aren't satisfied with the way your pension savings account funds are being managed, you can switch to another investment company. When you change jobs, you take your pension savings account with you. It's as portable as your bank account.

Moreover, Chileans can now decide when they wish to retire. A worker figures how much he has accumulated thus far in his pension savings account and what additional percentage must be deducted from each paycheck so that when his chosen retirement date arrives, he will be able to buy an annuity yielding 50 percent of his last wages.

The Chilean Constitution protects pension savings accounts from government expropriation. Taking politics out of the system means that pressure groups can't lobby legislators to siphon a worker's money for somebody else.

With the Chilean system, everybody goes through life contributing at least 10 percent of earnings. If by the time a man reaches 65, or a woman 60, an individual can't afford to buy an annuity yielding a minimum income, then the government supplements their accumulated capital to reach that level. But we retained the vital link between work and reward. The more you put into your pension savings account, the more you will be able to take out.

To handle the transition from a government-run system to a private pension saving system, we had three steps. First, we continued paying the elderly who had become dependent on the government-run system. We didn't touch those benefits. Second, we offered every worker the freedom to stay in the government-run system at his own risk. Or the worker could leave the system completely and begin his or his own pension savings account. Third, we required new entrants to the labor force to join the pension savings account system, because we believed it was irresponsible to go on burdening our children and grandchildren with an unfunded debt.

After the new law took effect, people who started working for the first time made payroll contributions to their own pension savings accounts, not the government-run system.

There was a transition gap: the amount of money we ceased to collect from workers who opted out of the system, yet had to pay current and future retirees. The transition gap was around 3 percent of our gross national product (GNP). We paid a substantial portion by reducing wasteful government spending and by using debt financing. As a consequence, we went to private pension accounts without increasing taxes, inflation or interest rates.

Going to pension savings accounts helped boost the economy, because it has raised the saving rate - now about 27 percent of GNP - and people's contributions became available for private capital markets. Pension savings accounts have generated capital equivalent to 40 percent of Chilean GNP. During the past dozen years, annual growth has been about 7 percent, double our historic growth rate.

The real rate of return on private pension accounts has been about 12 percent. Pensions are already 50 percent to 100 percent higher than the government-run system.

Chile has eliminated the payroll tax, which, by making it more expensive for employers to create jobs, put a damper on employment. Chilean unemployment is around 5 percent - and without the disguised unemployment of government make-work jobs.

To be sure, Chile embraced many other free-market reforms which helped accelerate economic growth. We went to free trade, cut income taxes, privatized state-owned companies, and so on, but according to many observers, the most important reform has been pension reform. I believe that the way to cut the size of government is not only to reduce government programs but to abolish them.

A system like this could revolutionize the U.S. economy. People see their own efforts, not the government's, as offering the key to their future. Individuals would gain freedom to control their pension savings. They would almost certainly have more retirement income and greater piece of mind. It would be hard to think of a single economic reform that would do more good for everyone. MEMO: Jose Pinera, former Minister of Labor and Social Security of

Chile, is president of the International Center for Pension Reform and

co-chairman of the Cato Institute's Project on Social Security

Privatization.

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