This week I’m focusing on the myths that will keep investors from grasping the risks and opportunities on the road ahead as President George W. Bush pushes for restructuring Social Security — probably with the introduction of private accounts that could be invested in the stock market. Trust me on this — it’ll pay big dividends for you to get ahead of the curve on this one, because nobody is taking it seriously. If it happens, it will mean the biggest economic transformation since the oil crisis of the 1970s — and its impact on the markets will be just as big.

The first myth is that Social Security is so horribly broken, so utterly bankrupt — and yet so utterly ingrained in the American political landscape — that there is nothing we could ever possibly do to restructure it.

Yes, it seems impossible indeed. Especially considering what a poor, backward and underdeveloped country America is. To meet the challenge of restructuring Social Security, we’d have to be a rich, advanced and developed country — like Chile. That’s right, Chile… the third-rate third-world country that brilliantly succeeded in 1981 in a challenge that we haven’t even grasped more than two decades later. 20 years ago Chile completely — and totally successfully — restructured its bankrupt social security system into an exemplary program of private investment accounts, and transformed itself from a nation of serfs into a nation of investors.

Chile started even deeper in the hole than we are. When they implemented their restructuring, the implicit debt of their former system was a crippling 80% of gross domestic product. Here’s how they dug their way out.

First, the Chilean government guaranteed those already receiving benefits that their payments would be unaffected by the restructuring. Second, every worker already contributing to the old system was given the choice of staying in that system or moving to the new one. Those who left the old system got a tradable “recognition bond,” reflecting the value of the claims the worker had already acquired on the old system. The vast majority elected to move to the new system. And third, all new entrants to the labor force were required to enter the new system.

Under the new system, every worker opens a Pension Savings Account (PSA). During his working life, he automatically has 10% of his wages (up to total wages of $22,000 per year) deposited by his employer each month in his PSA — and he’s not taxed on the amount deducted. A worker may voluntarily contribute an additional 10% of his total wages each month, also free of taxes.

The PSAs can be invested in a variety of investment vehicles provided by private investment management companies, including mutual funds, banks, credit unions, and insurance companies. When the worker retires, he may begin to withdraw money from his PSA — at which time he’s taxed on the amount withdrawn, at ordinary income rates depending on his total income at the time. Sounds an awful lot like a 401(k) plan, doesn’t it?

After the first 15 years of operation, Chile’s PSAs had already accumulated over $25 billion, a huge pool of internally generated capital for a developing country with only 14 million people and a GDP of only $60 billion. The system is yielding retirement benefits representing a far greater fraction of lifetime working income, and it requires far smaller fraction of current income to be contributed.

According to Jose Pinera, Chile’s Minister of Labor who masterminded the PSA system and the transition to it,

“When the PSA was inaugurated in Chile in 1981, workers were given the choice of entering the new system or remaining in the old one. Half a million Chilean workers (one fourth of the eligible workforce) chose the new system by joining in the first month of operation alone far more than the 50,000 that had been expected. Today, more than 90 percent of Chilean workers who had been under the old system are in the new system. By 1995, 5 million Chileans had PSA accounts, although not all belonged to active, full-time workers, and therefore not all contribute in any given month.

“The bottom line is that when given a choice, workers vote with their money overwhelmingly for the free market — even when it comes to such ‘sacred cows’ as social security.”

So much for the myth that we can’t fix Social Security. If Chile can do it, we can do it!


The views expressed within represent those of the author, and do not necessarily reflect those of Capitalism Magazine’s publishers.