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8/11/2019 Medved Eff Chile

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Social Security in Chile


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Demographics Chile

15,980,912 people

0-14 years: 25.2% 15-64 years: 66.7%

65 and up: 8%

Population Growth

Rate: 0.97%

Birth Rate: 2.02

USA

295,734,134 people

0-14 years: 20.6% 15-64 years: 67%

65 and up: 12.4%

Population Growth

Rate: 0.92%

Birth Rate: 2.08


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Economic Performance Chile

GDP (PPP) $170

Billion Real GDP growth:

6.06 %

GDP per Capita

(PPP) $10,630.97 GDP per Capita

growth: 4.85 %

United States

GDP (PPP) $12.37

Trillion Real GDP growth:

3.5%

GDP per Capita

(PPP) $41,800 GDP per Capita

growth: 3%


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GDP per CapitaGDP per Capita

0

5000

10000

15000

20000

25000

30000

35000

40000

197

5

197

7

197

9

198

1

198

3

198

5

198

7

198

9

199

1

199

3

199

5

199

7

199

9

200

1

200

3

Time (years)

GDPperCap

ita(PPPadjusted,constant20

00$us)

Chile GDP per capita, PPP (constant 2000international $)

Latin America & Caribbean GDP per capita, PPP(constant 2000 international $)

United States GDP per capita, PPP (constant 2000international $)


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GDP Growth

GDP Growth

-15

-10

-5

0

5

10

15

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

Time (years)

G

DPGrowth(annual%)

Chile GDP growth (annual %)

Latin America & Caribbean GDP growth (annual %)

United States GDP growth (annual %)


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Origins of Social Security Social Security is a system by which living

wages are paid to those who are retired. It is

designed to enable the elderly and disabledto retire, but to still earn monthly incomes.

In 1898, Chile was one of the first AmericanNations to implement a Social Security

program.

The United States did not adopt SocialSecurity until 1935.


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Origins of Social Security 1924: Government of Chile established a

national social insurance system for workers.

A response to pressure exerted by the growingnumber of worker organizations and strikes.

Originally called Caja, the program was modeledafter system pioneered by Otto Von Bismarck in

the German Empire. Employee and Employer contributions to a state

run fund.


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Origins of Social Security 1952: Government of Chile reorganized

the The Workers' Security Fund.

Created a Social Insurance Service.

This system lasted until after1973, when Salvador Allende

was overthrown in a militarycoup by Augosto Pinochet.


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Social Security and the Military Coup The new military government eliminated the

traditional pay-as-you-go (PAYG) system.

This system was similar to the system still used bythe United States, involving mandatory tax basedcontributions.

Laid the groundwork for the current

privatized social security system, whichinvolves mandatory contributions, with fixedexceptions.


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Pay-as-you-go The government takes a percent of

workers monthly salaries and deposits

it into a general social security fund. This fund directly finances social security

benefits paid to those currently retired:

A PAYG type system relies entirely onthe willingness of younger generationsto work.


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How it Works The General Social Security Account, which is not

an investment in the economy, is merely aholding place to keep the money until it is paidout in benefits. Any surplus that is in this general social security

account, the government lends to itself. However,there are no funds earmarked to repay this debt,

meaning when it comes due, the government mustincur new debt or raise taxes.

Various estimates from government actuariespredict the bankruptcy of the US Social Security

system by 2030.


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Fixing Social SecurityAlthough predicted bankruptcy is not

for another 25 years, the problem

needs to be resolved. Two main options arise to fix the

solvency problem:

Changing the tax structure.

Privatization.


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Four Types of Tax Systems Progressive tax systems are those in which,

as income rises, the tax percent increases.

Regressive tax systems are those in which, asincome rises, the tax percent decreases.

Fixed percent systems are characterized byeveryone paying the same percent,

regardless of income. Lump sum tax systems demand a required

payment, regardless of income and percents:everyone pays the exact same amount.


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Four Types of Tax Systems


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Chiles New System Chiles private social security system was

implemented in 1981 due to non-solvency of theold system, in part from differential treatmentamongst various retirees.

The new system privatized social security intopublicly mandated but privately administeredpersonal accounts. In the formal sector, 10% of workers monthly

earnings are deposited into their private account.

There are a variety of private companies from whichto choose, who invest the monthly deposits.


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How the New System Works Each worker deposits 10% of monthly

earnings, which the investment firms take

and reinvest into stocks and bonds. This is similar to the idea of a mutual fund.

Preferential tax treatment:

The money deposited each month is done so

without paying taxes on said earnings.

Withdrawals are subject to government taxes.

Retirement age: Men: 65, Women: 60.


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How it Works Money goes into the accounts and is

not-touchable until retirement.

Upon withdrawal in retirement, funds aresubject to fees and taxes.

New policy additions have createdvoluntary savings accounts, withpreferential tax-treatment, which canonly be accessed a total of four timesper year.


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Workers in Transition During the transition process, the

government bore all of the costs, and paid

out benefits from the general budget. Workers who contributed to the PAYG system,

received recognition bonds, which guaranteed 4%annual, inflation adjusted yields.

These bonds were put into private savings accounts. This process was expensive, reaching upwards of

5% of total GDP in 1983.


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Requirements The managing firms are required by law to

pay no less that 70% of the monthly salary

earned by each client. If they have not earned sufficient revenue on

investments and cannot pay the allotted monthlyamount, the firm must cover it out of their own

reserves. If the firm cannot cover the payments, the

government, which insures the system, must stepin to pay.


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The Macroeconomic Model Y = C + I + G + NX

National Savings:

YCG = I + NX Savings = (YTC) + (TG)

Savings = Private + Public

In a PAYG system, social security contributions

appear in taxes and government spending, but donot factor into savings, since they are not saved.

In Chiles privatized system, required deposits areare accounted for in private savings.


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A New Model Create a model in which savings is a

function of time, reform, and GDP per

Capita: S = f( time, reform, GDP per Capita)

Predictions:

Given what we know about private socialsecurity systems, this model ideallypredicts a discontinuous best fit line, withthe break in the year of initial reform.


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A New Model


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A New Model Best fit lines cannot be discontinuous.

Knowing this, the data based line should

be more steeply upward sloping.

Specific data taken from regression results:

Y-int: -1.32 x 10^12 Slope: 4.48 x 10^8


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A new model


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Results of the New Model It is visible in the regression data

results that this model produces a very

accurate prediction: It explains over 96% of the relationship.

There is a .05 % probability that the

relationship occurs by chance alone.


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The Reality of Private Systems Since the first generation to work and live

under this private system are currently

retiring, the actual effectiveness of thesystem is becoming visible.

What has actually happened?

Change in incentive structure: Moral Hazard.

Some informal sector workers contributed only enoughmoney to be guaranteed the minimum retirementbenefits, meaning the investment firms or governmentwould have to cover the difference.


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The Reality of Private Systems There is a large dissatisfaction in Chile with the

private system: Hidden withdrawal fees eat away final value of

savings. Some of these fees go to pay the costs of the investment

firms.

In the USA, 99% of investment goes towards benefits and1% towards overhead.

In Chile, overhead is about 20 times as large.

There is a large underground economy in Chile. This,coupled with seasonal and self-employed workers,means roughly that only 60% of all workers are

actually covered by the private system.


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The Reality of Private Systems The private system is required to pay at least

$140 per month per worker. However,frequently the investment firms cannot meetthese payments. Investment firms use up their reserves, and then

need the government to step in and bail them out.

The government of Chile is still spending large

amounts of money to support the social safetynet, which should ideally have been providedentirely from the private pension system. This is to support the people who do not have large

enough lifetime earnings to support their retirement.


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Poverty Cohorts


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Why? There are a variety of reasons why

the privatization of social security

could be beneficial: Reduction in government spending.

Reduction in government debt.

Increase private savings.

Increased standard of living during retirement.

(Re-)Investment in the economy promotes highergrowth and many other things.

Source: Poverty and Income Distribution in a High Growth Economy, 1987-98, World Bank.


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Final Thoughts Both PAYG and private social security

systems have their perks and pitfalls,

and the solvency of each is debatable. What will the future be of each type of

system?

Which system would be easiest to reformto more adequately support the retiredpopulation?

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