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Chile’s Pension Crunch

SANTIAGO – Defined-benefit pension plans are under pressure. Changing demographics spell trouble for so-called pay-as-you-go (PAYG) systems, in which contributions from current workers finance pensions. And record-low interest rates are putting pressure on funded systems, in which the return from earlier investments pays for retirement benefits. The Financial Times recently called this pensions crunch a “creeping social and political crisis.”

Defined-contribution, fully-funded systems are often lauded as the feasible alternative. Chile, which since 1981 has required citizens to save for retirement in individual accounts, managed by private administrators, is supposed to be the poster child in this regard. Yet hundreds of thousands of Chileans have taken to the streets to protest against low pensions. (The average monthly benefit paid by Chile’s private system is around $300, less than Chile’s minimum wage.)

Chile’s government, feeling the heat, has vowed to change the system that countries like Peru, Colombia, and Mexico have imitated, and that George W. Bush once described as a “great example” for Social Security reform in the United States. What is going on?

The blame lies partially with the labor market. Chile’s is more formal than that of its neighbors, but many people – especially women and the young – either have no job or work without a contract. High job rotation makes it difficult to contribute regularly. And it has proven difficult to enforce regulations requiring self-employed workers to put money aside in their own accounts.