Latin America’s AGING CHALLENGE

Demographics and Retirement Policy in Brazil, Chile, and Mexico

Latin America’s AGING CHALLENGE

Demographics and Retirement Policy in Brazil, Chile, and Mexico

by Richard Jackson, Rebecca Strauss, and Neil Howe with contributions by Gabriela Aparicio and Keisuke Nakashima

GLOBAL AGING INITIATIVE CENTER FOR STRATEGIC AND INTERNATIONAL STUDIES MARCH 2009 contents

INTRODUCTION 1 CHAPTER 1 THE DIMENSIONS OF LATIN AMERICA’S AGING CHALLENGE6 The Demographic Transformation 7 The Old-Age Dependency Challenge 11 The Promise of the Demographic Dividend 12 The Development Challenge 16 CHAPTER 2 LATIN AMERICA’S PENSION REVOLUTION 20 The Advantages of Funded Pensions 21 A Personal Accounts Report Card 23 CHAPTER 3 RETIREMENT REFORM IN CHILE, MEXICO, AND BRAZIL 28 Chile 30 Mexico 33 Brazil 36 CONCLUSION LATIN AMERICA AT A CROSSROADS 42 A NOTE ON DATA AND SOURCES 48 A KEY TO CHART SOURCE CITATIONS 50 ACKNOWLEDGMENTS 51 ABOUT THE AUTHORS 52 ABOUT CSIS 53 introductionIntroduction When people in other parts of the world think of Latin America, they usually picture demographically youthful societies characterized by lofty birthrates, large families, and chronic labor surpluses. The challenge is a population that is too young and growing too fast.

While these popular images reflected reality in much of Latin America as recently as the 1980s, they are now hopelessly out-of-date. Latin America, in fact, is in the midst of a far-reaching demographic transformation. Fertility has fallen precipitously throughout most of the region over the past several decades and is now near, at, or even beneath the 2.1 replacement rate in most major countries, including Brazil, Chile, and Mexico—the three countries on which this report focuses. Meanwhile, life expectancy has soared and is approaching developed-world levels.

The number of elderly in Brazil, Chile, and Mexico, may have 1 Latin America will triple as older populations than the United a share of the population States. (See figure 1.) by 2050. The coming age wave poses two fundamental challenges for Latin The result will be a dramatic America. The first is to fashion slowdown in population growth national retirement systems capable and an equally dramatic aging of of providing an adequate level of the population. The United Nations support for the old without imposing projects that the share of Latin a crushing burden on the young. America’s population that is aged The second is to boost living 65 or over will triple by mid-century, standards while populations are from 6.3 percent in 2005 to 18.5 still young and growing. While the percent in 2050.1 Meanwhile, Latin United States, Europe, and Japan America’s median age will climb all became affluent societies before by 14 years, from 26 to 40. Latin they became aging societies, Latin America’s coming age wave is by no America may grow old before it means the largest in the world. grows rich. Unless Latin American By 2050, over 30 percent of the countries succeed in promoting more population will be aged 65 or over in rapid development and raising the some fast-aging countries in Europe growth path of their economies, and East Asia. But incredibly, several many will have to pay for age waves Latin American countries, including

1 Unless otherwise noted, all population projections cited in this report refer to the UN’s 2006 Revision “medium variant.”“Children” refers to the 0 to 19 age bracket, “working-age adults” to the 20 to 64 age bracket, and “elderly” to the 65 and over age bracket. The UN projections, as well as other major data sources cited in the report, are discussed in “A Note on Data and Sources.” Latin America’s population will age dramatically. Elderly (Aged 65 & Over), as a Percent of the Population, 2005–2050

1 25% 22.1% U.S. in 2050 = 21.0% 21.0% 21.2% n o

i 20% t a

l 19.4% u p o

P 15% 14.3%

e h t 11.2% f 10.6% o

t 10% 10.7% n 8.1% e c r 6.1% e 5.8% P 5% of developed-world proportions with a fraction of the developed world’s 0% income and wealth. The future 2005 2025 2050

could bring widespread economic Brazil* Chile Mexico hardship—even a humanitarian *The lower projection for Brazil is the UN medium variant; the higher projection is by CSIS and assumes a aging crisis. constant 1.8 fertility rate. Source: UN (2007) and CSIS calculations Latin America is making impressive progress in meeting to become an enormous burden on that Latin America’s funded pension the aging challenge. the economy as its population ages. systems can, over the course of a 2 Yet it too is building a voluntary working life, deliver higher benefits Latin America is making impressive private system of complementary at lower contribution rates than the progress in meeting both challenges. funded pensions. pay-as-you-go systems they replaced. On the retirement front, it has become To be sure, funded systems subject a laboratory for pension reform— The global financial crisis and the retirement benefits to the risks of ups and an inspiration to reformers in plunge in world stock markets are and downs in financial markets. developing countries around the causing policymakers in some Latin Economists largely agree, however, world. Chile led the way in the early American countries to question the that workers nearing retirement can 1980s, when it initiated a transition wisdom of basing old-age security be protected from sudden financial from its traditional pay-as-you-go on funded retirement savings. One downdrafts by prudent regulations public pension system to a fully country has gone beyond questioning. that require them to move into funded system of personal retirement Argentina, which introduced a dual fixed income assets at older ages. accounts. Since then, nine other Latin public pension system with parallel A growing number of Latin America’s American countries have enacted pay-as-you-go and personal accounts personal accounts systems, including reforms that shift their public pension options in the mid-1990s, nationalized Chile’s and Mexico’s, now encourage systems at least in part to a funded its pension funds in November 2008 such lifecycle portfolio allocation. basis. Among the three countries and is now shifting back to a purely The financial risk of a funded system, featured in the report, Chile and pay-as-you-go system. of course, can never be entirely Mexico have fully “privatized” While these concerns are understand- eliminated. But neither can the their public pension systems. Brazil able, they are misplaced. An effective “political risk” of a conventional maintains a purely pay-as-you-go retirement policy must focus on the pay-as-you-go public pension public pension system that threatens long term—and there is no question system—that is, the risk that future politicians will reduce its benefits. investment rules also make it difficult workers—and in some countries the That risk will rise steadily as Latin for pension fund managers to maxi- great majority—will thus arrive in old America ages and the ratio of mize long-term risk-adjusted returns— age with an inadequate pension or no beneficiaries to workers soars. and hamper their response to near- pension at all. They will be dependent term crises like the one that now grips on social assistance to keep them out Latin America’s funded financial markets. Meanwhile, with the of poverty, or else they will have to fall pension systems confer exception of Chile, most countries are back on traditional family support important advantages in failing to realize the full macro benefits networks, which will themselves be confronting the age wave. of their funded retirement systems. weakening as families shrink in size. While experts agree that these systems A high level of elder dependence on There are other potential advantages 3 are already playing a crucial role in the subsidized “minimum pensions” and to funded systems. Unlike pay-as- development of Latin American capital means-tested social assistance may you-go systems, which will impose markets, most countries have financed be manageable in today’s relatively a rising burden on workers and the “transition cost” from pay-as-you- youthful Latin America. In the much taxpayers as societies age, funded go to funded systems by issuing debt, older Latin America of 2030 or 2050, systems take pressure off public which means that the potential boost to the economic and social costs will budgets. In the near term, they can national savings may never materialize. be enormous. help to broaden and deepen Latin America’s capital markets. In the The greatest cause for concern Latin America’s retirement and long term, they can help to buoy up is the limited reach of formal development challenges are thus national savings, which is likely to retirement systems. closely related. The right kinds of decline as dependency burdens rise. retirement policies can make successful Along the way, they can foster a The greatest cause for concern, development easier by minimizing the middle-class ethos of thrift and however, is the limited reach of Latin fiscal burden of Latin America’s aging stewardship and, over time, help to America’s formal retirement systems— populations, increasing rates of savings narrow today’s high levels of inequality and this is a problem that applies and investment, and speeding the in income and wealth. equally whether they are funded or development of capital markets. pay-as-you-go. The large size of Latin But successful development is also To be sure, there are real problems America’s informal labor markets essential to long-term retirement with Latin America’s funded retirement means that much of the workforce security, which will prove elusive so systems. At the micro level, high fails to contribute regularly to the long as informal labor markets are administrative fees can eat into worker public pension system. Many so large and inequality is so high. account balances. Overly restrictive Latin America may be breaking percent in 2008 to 1.1 percent in sources of international investment. out of its low-growth trap. 2009.2 Mexico, which is more Meanwhile, strong domestic demand, economically intertwined with the especially in Brazil, should provide There are encouraging signs that United States, may slow even more. some protection from the sour the region may finally be breaking out Yet Latin America is much better international economic climate. of its low-growth trap. Chile led the positioned to weather today’s global way here as well with its program of economic storm than in the past. It Despite the progress, Latin market reforms in the 1980s—and is used to be that if the developed world America’s long-term economic now the only major Latin American caught a minor cold, Latin America success is far from guaranteed. country that is steadily closing the caught pneumonia. According to 4 Yet despite Latin America’s real income gap with the developed world. leading international institutions, from progress, its long-term economic Since then, many other countries the IMF to the Economic Commission success is far from guaranteed. have pursued similar reforms, and for Latin America and the Caribbean While the recent improvement in the economic outlook is improving (ECLAC), this time around could be the macroeconomic environment throughout the region. Per capita different. Latin American economic has been impressive, burdensome GDP, the most fundamental measure fundamentals are stronger. Public business and labor-market of living standards, grew more rapidly debt levels are lower, monetary regulations continue to hamper regionwide from 2002 to 2007 than and fiscal policies sounder, and the region’s international over any five-year period since the international currency reserves deeper. competitiveness. Most experts early 1970s. Brazil appears to be Chile, with its large reserve fund set agree that Latin American countries solidifying its place in Goldman Sachs’ aside during the recent commodity underinvest in human capital, “BRIC” tetrarchy of emerging global boom, may be particularly resilient. perhaps the most crucial input that economic powers—and some suggest Most Latin American countries are also has propelled the East Asian Tigers that Mexico should be added, less vulnerable to the vagaries of single into the economic stratosphere. changing the acronym to BRIMC. export markets and less dependent Informal sectors show little sign of on the developed world. The United As this report goes to press, Latin shrinking—and in some countries are States and Europe constitute a America, like most of the world, is growing. Meanwhile, despite recent shrinking share of their export in the midst of a serious economic declines in poverty, Latin America’s markets, while Asian and other Latin downturn. The IMF expects Latin historically high rates of inequality American countries are a growing America’s economic growth rate to have barely budged, even in the share. The same shift has occurred in slow from 5.7 percent in 2007 and 4.6 region’s fastest-growing economies.

2 “World Economic Outlook Update,” International Monetary Fund, January 28, 2009, http://www.imf.org. Latin America has a performance, the size of their welfare In this regard, we believe that Chile’s demographic window of states, and, of course, retirement 2008 “reform of the reform,” with opportunity to prepare for reform—from Chile (the original its new “solidarity pensions,” its age wave. “privatizer”) to Brazil (with its large provides a promising model. A pay-as-you-go pension system). conclusion then briefly summarizes The good news is that Latin America Together, they account for a little the report’s findings and points to still has time to prepare for the aging over half of Latin America’s some of the broader implications of of its populations. Unlike the age population and nearly two-thirds Latin America’s aging for the future waves confronting today’s developed of its GDP. shape of its societies and place in countries, Latin America’s still lies the world economy. Chapter 1 further explores the well over the horizon. For the 5 dynamics of demographic change in A Latin America that fails to confront next two decades, the number of Latin America and the challenges and the aging challenge will be a Latin dependent young in most countries opportunities it poses. Chapter 2 America in which economic and will continue to fall faster than the takes a close look at Latin America’s social insecurity grow and today’s number of dependent elders will rise, personal account model and assesses uneven distribution of income and meaning that society’s overall its strengths and weaknesses. wealth hardens over time. On the dependency burden will decline Chapter 3 zeros in on retirement other hand, a Latin America that as well. During this period of policy in Chile, Mexico, and Brazil. successfully prepares for the “demographic dividend,” population We conclude that reform momentum challenge will prosper as it ages. trends will tend to lean with is positive in all three countries— Living standards will rise and today’s economic growth. Latin America but that all three, with the possible vast disparities between rich and thus has a crucial demographic exception of Chile, will need to enact poor, urban and rural, and European- window of opportunity in which it additional reforms to ensure the and non-European-origin populations can boost living standards and adequacy and sustainability of their will steadily narrow. A Latin America strengthen its retirement systems. pension systems. We stress the that successfully prepares for the This report turns the spotlight on importance of strengthening funded challenge will also be one that is Latin America’s aging challenge. pension systems and outline a plan positioned to assume a much larger It focuses in particular on three for Brazil to gradually move in role in a world in which most of countries: Brazil, Chile, and Mexico. that direction. We also stress the today’s global economic powers will These countries represent a broad importance of constructing broad be aging even faster than it is. spectrum in terms of their economic and adequate floors of protection. The Dimensionschallengeof Latin America’s Aging Challenge CHAPTER 1

s of Latin America’s Aging Challenge challengeBy 2050, there will be as many people turning 65 each year in Latin America as being born. The coming age wave threatens to overburden the young and leave the elderly vulnerable to hardship in old age. Yet that need not happen if societies prepare for the challenge. The Chinese character for crisis is a combination of two separate characters, one for danger and one for opportunity. The same demographic forces that will ultimately bring about the dramatic aging of Latin America’s population have also created conditions today that are especially favorable to economic growth. There are encouraging signs that Latin America may seize its opportunity. But there are also serious obstacles, some deep-rooted in its history, that it will first have to overcome.

The Demographic Transformation

As recently as the 1960s and decelerating rapidly. The number of 7 1970s, Latin America had among children is due to peak within the the highest fertility rates, lowest next 10 to 15 years in most Latin median ages, and fastest population American countries, then decline. growth rates of any region in the In Chile and Mexico, the number world. Even into the 1980s and of children is already declining. 1990s, the great social and The number of young adults in economic challenge in most their twenties will peak and begin to countries was how to find sufficient decline almost everywhere within the resources to educate the young, next 20 to 25 years. By mid-century, house growing families, and create the total working-age population will jobs for the legions of new workers also be peaking in most countries— entering the labor force each year. and in Brazil, Chile, and Mexico, it will be falling. Latin America, however, is being overtaken by a stunning By 2050, there will be demographic transformation. one Latin American elder Over the past few decades, the for every child. population growth rate has dropped dramatically, from 2.7 percent per Even as the number of children and year in the 1960s to 1.3 percent per working-age adults grows slowly or year in the 2000s—and it is still declines, the number of elderly is While the number of children and working-age adults will grow slowly or decline, the number of elderly will explode. Percentage Change in the Latin American Population by Age Group, 2005–2050 2 350% 307.1% 300% Percentage Change: 2005–2050 e

g 250% Age 0–19 Age 20–64 Age 65+ n

a Brazil -13.0% 36.3% 330.0% h

C Chile -17.0% 21.6% 246.6%

200%

e Mexico -29.1% 32.4% 361.6% g a t 150% n e c

r e

P 100%

50% 45.2%

0% due to explode, quadrupling by 2050. -15.3% -50% (See figure 2.) As recently as 1975, Age 0–19 Age 20–64 Age 65 & Over

there were 12.3 children in Latin Source: UN (2007 ) America for every one elder. Today there are 6.3. By 2050, there will slightly longer than in the United be just 1.3. A generation ago, the Since the early1950s, States. (See figure 3.) 8 problem was too many babies. Latin American life expectancy A generation from now, it will be has increased by a stunning In most of Latin America, mortality too many old people. 22 years. began to fall well before fertility did— which is what explains Latin America’s There are two forces behind The demographic transition began to population boom. As recently as Latin America’s demographic gather momentum in most of Latin the late 1960s and early 1970s, the transformation: falling fertility and America in the 1950s and 1960s, fertility rate—or the average number rising longevity. The first force is when improvements in nutrition, of lifetime births per woman—still decreasing the relative number of sanitation, and basic public health led towered in the 4.0 to 7.0 range young in the population, while the to a dramatic decline in infant and almost everywhere in the region. The second force is increasing the relative child mortality rates. In more recent major exceptions were more ethnically number of old. Latin America, of decades, mortality has also declined European Argentina and Uruguay, course, is not the only region of the rapidly at older ages as modern where the demographic transition had world experiencing these trends. Like medicine has made steady progress begun much earlier and fertility rates the developed world before it, most of against the chronic diseases that afflict hovered around 3.0. With birthrates the developing world is now in the the middle-aged and elderly. The high and infant and child mortality midst of what demographers call the resulting increase in life expectancy falling, population growth surged. “demographic transition”—the shift has been stunning. Since the early from high fertility and high mortality 1950s, life expectancy in Latin America In Brazil and Chile, fertility (the traditional norm) to low fertility has increased by 22 years regionwide, has fallen beneath the 2.1 and low mortality (the modern norm) from 51.4 to 73.3. In Chile, where life replacement rate. that inevitably accompanies social and expectancy reached an estimated 78.7 economic development. in 2008, people can now expect to live Behind Latin America’s age wave: A dramatic rise in life expectancy. Life Expectancy at Birth in Latin America, 1950–2010 3

80 Life Expectancy in 2007 Latin America 73.3 73.3 75 72.0 Brazil 72.6 70.6 70 Chile* 78.7 68.6 y Mexico 75.0 66.9 c 65.0 United States 78.0 n 65 63.0

a 60.9 t

c 60 58.8

e 56.8

p 54.3 55 x 51.4 E

e 50 f

i

L 45

40

35

30 1950–55 1955–60 1960–65 1965–70 1970–75 1975–80 1980–85 1985–90 1990–95 1995–00 2000–05 2005–10

*Data are for 2008. Source: UN (2007); CONAPO (2008); IBGE (2007); INE (2008); and U.S. Census Bureau (2008)

The fertility decline may have The timing and magnitude of the fell earliest, now have the oldest come late to most of Latin America, fertility decline in different countries populations among major Latin 9 but once it began it proceeded at a will largely determine the timing and American countries. Mexico, Brazil, stunning pace. Over the past three magnitude of their age waves. and Chile are still much younger. But decades, fertility rates have fallen by at Argentina and Uruguay, where fertility because their fertility declines have least half in the majority of countries, sinking beneath 3.0 everywhere Behind Latin America’s age wave: except Bolivia, Paraguay, and a few An equally dramatic decline in fertility. Central American countries with large Total Fertility Rate, 1950–2010 indigenous populations. In Brazil and Chile, fertility has apparently slipped 8.0 7.0 beneath 2.1, the so-called replacement 6.7 6.5 rate needed to maintain a stable 6.2 e 6.0 t a

population from one generation to the R

5.0

y 5.0 4.7 t i l next. Nowhere, however, has the i t r

e 4.0 3.6 decline been more precipitous than in F

l a Mexico, whose fertility rate has fallen t 3.0 o T 2.2 2.2 by two-thirds since the early 1970s. 2.0 1.9 (See figure 4.) Now estimated at 2.2, 1.8* 1.0 it is almost identical to the overall U.S. 0 fertility rate of 2.1—and far lower Brazil Chile Mexico than the 3.1 fertility rate of the 4 1950-55 1970-75 2005-10 Mexican-origin population living *Brazilian government’s estimate for 2006. in the United States.3 Source: UN (2007) and Minist ério da Saúde (2008)

3 See Joyce A. Martin et al., National Vital Statistics Reports 56, no. 6 (Hyattsville, MD: National Center for Health Statistics, December 5, 2007), 45. been so steep, they will eventually (epitomized in Brazil’s telenovelas) while Mexico would reach it by 2020 catch up with their older neighbors that glorify small families and and Brazil by 2030. In the case of in Latin America’s Southern Cone. independent lifestyles. Brazil, the future appears to have In the case of Mexico, the aging of arrived early. The latest Brazilian its population is being given an extra Latin America’s fertility government data published in July push by the large out-migration of decline may not yet have 2008 indicate that Brazil’s fertility rate working-age adults. Colombia also run its course. had already sunk to 1.8 in 2006, far faces a large age wave. In Bolivia, beneath previous estimates that put Indeed, Latin America’s fertility Ecuador, Paraguay, Peru, and it somewhere between 2.2 and 2.3.4 decline may not yet have run its Venezuela, where fertility still remains If the new number is accurate, Brazil’s course. Behind the averages for most 10 significantly above replacement, the elderly share could reach 21.0 percent countries, there are still wide variations aging trend will be less severe. by 2050, significantly higher than the in fertility between socioeconomic and 19.4 percent that the UN projects for The forces driving the demographic ethnic groups, with the best-educated Brazil and on a par with its projections transition are rooted in powerful social women (who are disproportionately for Mexico (21.2 percent) and Chile and economic trends that few experts of European descent) having lower (22.1 percent).5 expect to be reversed. Absent a fertility rates than those of the least catastrophic pandemic, life expectancy educated women (who are Latin America’s age wave has will continue to rise. Future fertility disproportionately of indigenous already been set in motion and behavior is more difficult to predict, descent). Fertility is also much lower cannot be easily reversed. but since the underlying drivers of among urban populations than among Latin America’s fertility decline are so rural ones. This suggests that fertility Non-demographers may suppose that closely intertwined with the broader rates in Latin America may still have population projections so far into the currents of modernization in the room to fall, especially if societies are future must be highly speculative. But region, a major turnaround in successful in boosting educational this is not the case. The aging of Latin birthrates seems unlikely. These attainment and reducing inequality. America is the inevitable result of drivers include: urbanization (which demographic trends that have already The UN population projections that is especially high in Latin America), been set in motion. Unexpected shifts we use in this report assume that rising female educational attainment, in mortality or fertility, like the recent fertility will indeed continue to decline, the mass entry of women into the surprise in Brazil, may exacerbate or eventually falling to 1.85 in all market economy, the availability of mitigate the aging trend. The shifts, countries. According to the UN, effective contraception, and the however, would have to be very large Chile would reach that level by 2015, ascendance of new cultural norms

4 See PNDS 2006: Pesquisa Nacional de Demografia e Saúde da Criança e da Mulher (Brasília: Ministro da Saúde, 2008). 5 This alternative projection, made by CSIS using the DemoTools cohort-component projection software package, assumes a constant 1.8 fertility rate from 2005 through 2050. There will be fewer workers to support each elder. 5 Aged Support Ratio of Working-Age Adults (Aged 20–64) to Elderly (Aged 65 & Over) in Latin America, 1970–2010

o 12.0

i Aged Support Ratio t in Latin America a

R 1970 10.6 10.0 t 2005 8.7 r

o 2025 5.7

p 8.0 2050 3.1 p u S 6.0 d e g

A 4.0

2.0

0.0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Source: UN (2007) to substantially alter Latin America’s the average burden that must be Even as the old-age demographic trajectory—and even shouldered by each worker will triple. dependency burden grows, 11 then, they would take decades to have Much of this burden will fall on so will the vulnerability of much impact. Demography is like an families, which remain the primary the elderly. ocean liner. Once it is steaming full network of support for the elderly in speed ahead, it can only be turned Even as the old-age dependency many of Latin America’s younger around slowly. For better or worse, the burden grows, so will the vulnerability countries with less developed welfare countries of Latin America will have to of the elderly. In Latin America’s states. But much of the burden will cope with the aging challenge. Southern Cone countries, the also show up in government budgets. economic situation of the elderly at Among the three countries featured The Old-Age first glance seems relatively secure. in this report, the fiscal costs of aging Dependency Challenge Rates of pension receipt are high: will be greatest in Brazil, which already 66 percent in Chile and 92 percent in spends an enormous share of GDP As the countries of Latin America age, Brazil and Argentina. Poverty rates are (11.4 percent in 2006) on its pay-as- they will have to transfer a rising share also low—in fact, lower than among you-go public pension system. The of society’s income from working-age younger adults. This picture, however, costs will be more adults to nonworking elders. In 2005, is deceptive. A large share of today’s manageable in countries like Chile and there were 8.7 working-age adults in pensioners (in Brazil, two-thirds) receive Mexico that are transitioning to fully Latin America available to support subsidized “minimum pensions” or funded personal accounts systems. each elder. That ratio is due to sink to noncontributory “social pensions.” Yet here too, governments will 5.7 by 2025 and to 3.1 by 2050. These benefits may lift most elders out come under mounting pressure to (See figure 5.) In Brazil, Mexico, and of poverty, but they do not provide a spend more on pensions, health care, Chile, it will fall even further—to 2.9, secure source of retirement income. and social services for their rapidly 2.7, and 2.5, respectively. In effect, Given current trends, moreover, this is growing elderly populations. unlikely to change in the future. Two-thirds live with their children,6 and Retirement security will Although all of the Southern Cone even those who do not are highly depend as much on successful countries have ostensibly universal dependent on them for financial development as successful public pension systems, at least for support. Yet as family size shrinks and retirement policy. wage and salary workers, the large urbanization and immigration break size of their informal labor markets up extended families, these informal As we will see in the next chapter, the means that only a fraction of the support networks are coming under funded retirement systems that many workforce contributes regularly. In increasing stress even before the Latin American countries are now 2006, only 37 percent of Argentine age wave rolls in. For many elders, building can reduce the future burden workers, 41 percent of Brazilian remittances sent home by offspring of growing elderly populations 12 workers, and 64 percent of Chilean living in the United States are the sole on both families and government workers contributed to the public source of income. budgets. They can also improve the pension system. adequacy of retirement income for those workers who contribute As family size shrinks, In today’s relatively youthful Latin regularly. But so long as economic traditional support networks America, the limited reach of formal growth in Latin America remains slow, are already coming under retirement systems has already inequality remains high, and a large increasing stress. become a growing social problem. In share of the workforce labors in the tomorrow’s Latin America, with its informal economy, no pension system In the rest of Latin America, including soaring old-age dependency burden, can deliver widespread retirement Mexico, the economic situation of the it could become a social catastrophe. security. In the end, retirement security elderly is even more precarious. Just Old-age safety nets are vitally in an aging Latin America will depend 21 percent of Mexican elders now important, and countries like Mexico as much—or even more—on receive a public pension benefit of that lack one will need to create one. successful economic development as it any kind. Poverty is widespread, with They are not, however, a long-term will on successful retirement policy. nearly one-third of Mexican elders solution to the old-age dependency The Promise of the living on less than two dollars a day, challenge. If half or more of elders are Demographic Dividend the World Bank’s poverty threshold. still dependent on social assistance A large share continue to work— when Latin America’s age waves Latin America’s coming age waves nearly half of men aged 65 and over arrive, the economic and social costs and the steep rise in old-age in 2006—usually in agriculture or will be enormous. dependency costs they will bring still low-wage service-sector jobs. loom over the horizon. For the

6 Paulo M. Saad, “Arreglos residenciales y su influencia en la calidad de vida en la vejez” (presentation at the meeting of the Latin American Demographic Center [CELADE], Santiago, September 9, 2003). The demographic dividend: A declining total dependency burden. Total Dependency Ratio of Elderly (Aged 65 & Over) plus Children (Aged 0–19) per 100 Working-Age Adults (Aged 20–64), 1975–2050 6 170 Latin America 150 Total Working-Age o

i Dependency Population t

a Ratio as % of Total R

130

y 1975 128 44% c

n 2005 84 54% e

d 110 2005 2025 70 59% n

e 2050 75 57% p

e 90 D

l averages, of course, lies considerable a t

o 70 Brazil T diversity. In Argentina and Uruguay, Chile where fertility fell earlier and more 50 Mexico gradually, the demographic dividend 30 has been relatively small. In Brazil 1975 1985 1995 2005 2015 2025 2035 2045 and Mexico, the drop in the total Source: UN (2007) dependency ratio has been especially steep—and it will continue to fall until moment, demographic trends are of dependent elders rises, which around 2030, when the relative growth in the number of elderly finally leaning with economic growth—and, means that society’s total dependency 13 in most countries, will continue to do burden declines as well. This, of overtakes the relative decline in the so for the next two decades. In fact, course, is another way of saying that number of children. Chile is also population trends in Latin America a growing share of the population is experiencing a large demographic have never been as favorable as they in the productive working years. The dividend, but the total dependency are today, and they may never be as favorable demographics of this phase ratio will bottom out sooner, favorable again. Countries must of the demographic transition are around 2020. take advantage of this window of sometimes referred to as the Economists agree that the opportunity to strengthen their “demographic dividend”—and they demographic dividend can bring retirement systems and to boost open up a window of opportunity for important benefits. A falling living standards before the economic growth. dependency ratio and a rising share demographic climate changes. Latin America is already in the midst of of the population in the working its demographic dividend. The region’s years in and of itself tends to push Population trends in Latin up per capita incomes. Above and America will never again be as total dependency ratio—that is, the number of children and elders for beyond this simple arithmetic, the favorable to economic growth demographic dividend can also give as they are today. every 100 working-age adults—has fallen dramatically over the past few rise to other powerful dynamics that increase living-standard growth. The opportunity arises from decades, from 128 in 1975 to 84 in Labor-force participation rates may rise the dynamics of the demographic 2005. Meanwhile, the share of the as fewer children free up adult time, transition itself. When fertility first falls, population in the working years has and especially the time of women, for the number of dependent children surged from 44 to 54 percent. participation in the market economy. declines much faster than the number (See figure 6.) Behind these regional The growth in Latin America’s working-age 7 populations is decelerating. Average Annual Growth Rate in the Working-Age Population (Aged 20–64), 1975–2050

4.0%

e 3.5% t a Brazil R 3.0% h t Chile w 2.5% o r Mexico G

l 2.0% a u

n 1.5% n A 1.0% e

Over time, savings rates may increase g a

r 0.5% e

as more of the working-age bulge v

A 0.0% ages into its high-savings middle years. Smaller families may also be inclined -0.5% -1.0% to invest more in the “quality” of 1975–80 1985–90 1995–00 2005–10 2015–20 2025–30 2035–40 2045–50 their children—and thus of the future workforce. Source: UN (2007)

The dramatic deceleration in of their new consumable income accounts for between one-quarter and population growth could be an 14 and free time into more care per two-fifths of the growth in its per economic boon. child, more schooling per student, capita GDP since the mid-1970s.7 or more training or technology per The dramatic deceleration in worker—what economists call So far Latin America is failing population growth that follows a “capital-deepening” investment. Either to leverage its demographic large fertility decline can also be an way, living standards will tend to rise. dividend. economic boon. Many development economists consider a high rate of These dynamics are not merely The economic benefits of the population growth to be a problem theoretical. Economists who have demographic dividend, however, are because it requires poor and middle- studied the demographic transition conditional on the broader economic, income countries to spend so much agree that it has given a powerful social, and political environment in on capacity-enhancing investment boost to economic growth in East each country. There is no guarantee simply to avoid “capital dilution” and Asia, underpinning the stunning rise that a country will leverage its keep from falling behind. The rate of of South Korea and the other Tigers dividend—and in fact, most Latin growth in Latin America’s working-age and, more recently, of China. As in American countries have thus far populations is already slowing Latin America, fertility in East Asia has failed to do so. Although the total dramatically—and will continue to fallen dramatically since the late 1960s dependency ratio has been falling decelerate in the decades to come. and early 1970s, pulling down the in Latin America since the 1970s, (See figure 7.) As it does, societies total dependency ratio and pushing economic performance has been will be able to consume more while up the share of the population in disappointing. Between 1975 and maintaining the same rate of growth the working years. Many studies have 2007, per capita GDP In Latin America in the capital-to-labor ratio. They concluded that the shift in the age has grown at just one-sixth the rate may also choose to redirect some structure of East Asia’s populations that it has in East Asia—1.2 percent

7 See, for example, David E. Bloom and Jeffrey Williamson, “Demographic Transitions and Economic Miracles in Emerging Asia,” World Bank Economic Review 12, no. 3 (September 1998); and David E. Bloom, David Canning, and Pia N. Malaney, “Demographic Change and Economic Growth in Asia,” CID Working Paper no. 015 (Cambridge, MA: Center for International Development at Harvard University, May 1999). Living standards in East Asia have grown far more rapidly than living standards in Latin America. Cumulative Percentage Change in Real GDP Per Capita (in 2005 PPP Dollars), 1975–2007

900% 850%

800% Average Annual Growth Rate in Real GDP Per Capita, 1975–2007

e 700% Latin America 1.2% g

n Brazil 1.2% a

h 600% Chile 3.7% C

Mexico 1.4% e

g 500% China & East Asia* 7.3% a t n

e 400% c r e

P 8 300% to dependents—but this is only an 223% 200% advantage if societies can allocate the extra labor to productive jobs. 100% 58% 44% 46% The demographic dividend may also 0% China & East Asia* Latin America Brazil Chile Mexico mean a rising share of the population in the middle years—but the potential *Excludes Japan. Source: World Bank (2008a) and CSIS calculations boost to savings may not materialize unless families are confident that their per year versus 7.3 percent. While with the developed world, most thrift will yield returns over time. To living standards in developing East Asia Latin American countries are not. varying degrees in different countries, 15 have risen by 850 percent over the (See table 1.) East Asia’s success in leveraging its same period, in Latin America they The lesson of East Asia is that demographic dividend has depended have risen by just 44 percent. favorable demographics only help to on sound macroeconomic policies, (See figure 8.) Even in the fastest- the extent that societies can efficiently pro-business tax and regulatory growing country, Chile, they have allocate resources to value-added regimes, public confidence in the rule risen by just 223 percent. While East activities. The demographic dividend of law, and massive public investments Asia is closing the living-standard gap may mean a rising ratio of workers in infrastructure, R&D, and, above all,

Table 1 Most Latin American countries are failing to close the income gap with the developed world. G DP Pe r Capita (in 2005 PPP Dollars), as a Percent of Developed-World Average, 197 5–2007

1975 1980 1985 1990 1995 2000 2007

Latin America 35% 35% 30% 26% 26% 25% 26% Brazil 34% 36% 31% 27% 27% 25% 25% Chile 22% 26% 23% 25% 33% 33% 37% Mexico 41% 44% 40% 34% 32% 34% 34% China & East Asia* 4% 4% 6% 7% 10% 12% 18% China 2% 2% 3% 4% 7% 8% 14% Asian Tigers 26% 32% 38% 48% 61% 65% 76%

*Excludes Japan. Source: World Bank (2008a) and CSIS calculations human capital. Historically, many of As of 2007, Chile was running a cur- discipline and launching sweeping these conditions have not existed in rent account surplus and Brazil’s and market liberalization reforms in the Latin America. Mexico’s current accounts were close 1980s. Others followed suit in the to balance. Even as foreign direct 1990s and 2000s, including Brazil and The good news is that the investment has soared, Latin American Mexico. Budget deficits were reduced, environment in Latin America is multinational companies, or inefficient state-owned businesses improving rapidly. Although serious “Multilatinas,” have been leading were privatized, import tariffs were challenges remain, the prospects for an explosion of outward investment. lowered, and economies were growth and development in the region In 2006, Brazil was actually a net opened to foreign trade. International are brighter than they have been in source of FDI. Poverty rates have also agreements created regional trading decades. The demographic window of 16 fallen dramatically. Between 2003 blocs—first MERCOSUR in 1991 and opportunity has not yet closed—and and 2007 alone, the proportion of then NAFTA in 1994. To be sure, some there is still time to reap the benefits people in Latin America living under countries have bucked the broad of the dividend. national poverty lines fell by nearly regional trends, most notably Bolivia The Development Challenge one-quarter.8 and Venezuela. The progress has also Almost everywhere you look, been punctuated by severe financial From 2002 to 2007, economic trends in Latin America crises in Mexico (1994–95) and living standards in Latin have recently begun to point in Argentina (2001–02). But despite America grew faster than a positive direction. The region’s per the bumpy road, Latin America’s over any five-year period capita GDP grew faster from 2002 to improved macoeconomic outlook since the early 1970s. 2007 than over any five-year period is undeniable—as attested by the investment-grade status accorded by since the early 1970s. Inflation has Much of the credit for the Standard & Poor’s to the sovereign receded since the 1990s and appears turnaround goes to improved debt of Chile, Mexico, Brazil, and Peru. to have been contained in all of the macroeconomic management and region’s major economies except market liberalization. Latin America Much of the credit Argentina and Venezuela. Until the has repudiated the import-substitution for improved economic current global economic crisis, public policies of the 1960s and 1970s that performance goes to sound debt levels were also falling in most precipitated hyperinflation and debt macroeconomic management of the region, with especially large crises, leading to the “lost decade” and market liberalization. declines in Brazil, Chile, and Mexico. of the 1980s. Chile was the first to chart a new course, imposing fiscal

8 CEPALSTAT database, Economic Commission for Latin America and the Caribbean (ECLAC), http://www.eclac.org/. Table 2 Latin American countries score poorly in international competitiveness comparisons.

World Bank WEF “Ease of Doing Business Index” “Global Competitiveness Index”

Ranking (Out of 181) Ranking (Out of 134) 40 Chile 28 Chile 53 Colombia 59 Costa Rica 56 Mexico 60 Mexico 62 Peru 64 Brazil 109 Uruguay 74 Colombia 112 Guatemala 75 Uruguay 113 Argentina 83 Peru Latin America is now understandably 117 Costa Rica 84 Guatemala focused on the fallout from the global 125 Brazil 88 Argentina economic crisis, which has already 136 Ecuador 104 Ecuador 150 Bolivia 105 Venezuela slowed regional economic growth in 174 Venezuela 118 Bolivia 2008 and threatens to slow it further in 2009. Much more worrisome Source: World Economic Forum (2008) and World Bank (2008b) than the near-term crisis, however, are the persistent structural economic The improved outlook also owes Structural economic problems which, even when global growth resumes, may make it difficult much to a new ideology of policy problems may make it difficult 17 pragmatism—or what Javier Santiso, for Latin America to build on for Latin America to build on its Chief Development Economist at the its recent progress. recent progress. OECD, calls “the political economy Most Latin American countries of the possible”9 —that marries At the same time, Latin America’s score poorly in international fiscal discipline with social protection democratic consolidation is pushing competitiveness comparisons. policies. In many countries, fiscally the region toward greater stability. conservative policies originally In 1975, only 15 percent of Latin While the macroeconomic championed by the right have been America’s population lived in countries environment in Latin America has embraced by the left (for instance, that Freedom House characterized as improved, burdensome business Brazil and Chile), while in others social fully “free”; today, 74 percent does.10 regulations, punitive tax policies, and investment agendas championed by In a heartening testament to Latin overregulated labor markets continue the left have been embraced by the America’s political progress, not only to undermine competitiveness. In the right (for instance, Colombia and can anyone vote, but anyone World Bank’s most recent Ease of Mexico). Shifts in political power are can be elected—including members Doing Business Index, Chile (ranked now much less likely to lead to abrupt of indigenous populations (as we 40 out of 181 globally) and Mexico shifts in policy than they were in the have seen in Bolivia and Peru) and (56) are among the region’s best past. This long-term policy continuity women (as we have seen in Chile performers, while Brazil (125) ranks is crucial to economic growth for and Argentina). very low.11 (See table 2.) Brazil’s poor many reasons, perhaps the most Yet despite the dramatic turnaround, standing is, among other reasons, important one being that it boosts Latin America’s economic future due to its ponderous tax code, which investor confidence, both remains in doubt. Much concern in requires the typical business to spend domestic and foreign.

9 Javier Santiso, Latin America’s Political Economy of the Possible: Beyond Good Revolutionaries and Free-Marketeers (Cambridge, MA: The MIT Press, 2006). 10 Freedom in the World (Washington, DC: Freedom House, various years). 11 Doing Business 2009 (Washington, DC: The World Bank, September 2008). DEVELOPING ECONOMIES NEED TO INVEST HEAVILY IN R&D IF THEY ARE TO MOVE UP THE GLOBAL VALUE-ADDED SCALE.

an incredible 2,600 hours per year Latin America is also underinvesting in competitiveness for middle-income preparing, filing, and paying taxes. human capital development, arguably countries—and it is here that Latin 18 Latin American countries also score the most important determinant of America lags. Seventy-one percent poorly in the World Economic Forum’s long-term living-standard growth. of 25–26 year olds have completed Global Competitiveness Index, a To be sure, most countries have made secondary school in Chile, but just somewhat broader measure of the huge strides in educational attainment, 45 percent in Brazil and 36 percent overall economic environment. especially in universalizing primary in Mexico.14 From labor-market flexibility education. Mexico and Brazil, which The quality of secondary education in and technological readiness to long trailed regional leaders Argentina, most Latin American countries is also infrastructure and governance, the Chile, and Uruguay, have achieved widely acknowledged to be poor. region as a whole ranks below its near universal primary school On the Program in International main global competitors: India, China, attainment—thanks in part to Student Achievement (PISA) exams, the East Asian Tigers, and Central and programs such as Oportunidades in the gold standard in cross-country Eastern Europe.12 Only Chile, Latin Mexico and Bolsa Familia in Brazil, educational comparisons, students America’s top performer on almost all which provide income support to poor from Brazil, Mexico, and even Chile competitiveness indicators, ranks in families on the condition they keep score far lower than students in the top 50 (28 out of 134).13 their children in school. But universal developed countries—and lower primary education is not enough to than students in most countries with Latin American countries propel Latin America’s economies comparable per capita incomes.15 are underinvesting in forward. Development economists Skewed spending priorities may partly human capital. agree that universal secondary explain the poor performance. Most education is the key to international Latin American governments spend

12 Augusto López-Carlos et al., “Assessing Latin American Competitiveness: Challenges and Opportunities,” in Augusto Lopez-Carlos, ed., The Latin American Competitiveness Review 2006: Paving the Way for Regional Prosperity (Geneva: World Economic Forum, 2008). 13 The Global Competitiveness Report 2008–2009 (Geneva: World Economic Forum, 2008). 14 Data refer to 2003 for Brazil and Chile and to 2004 for Mexico. See Sociometro, Inter-American Development Bank, http://www.iadb.org/sociometro. 15 “A Profile of Student Performance in Reading and Mathematics from PISA 2000 to PISA 2006,” in PISA 2006: Science and Competencies for Tomorrow’s World (Paris: OECD, 2007). far more per student on university nonagricultural employment. Recent productive investment. In East Asia, education, which benefits a small elite, estimates put the share at 37 percent savings rates have surged during than on secondary education, which in Chile, 49 percent in Mexico, and the course of the demographic benefits the broad population. In 54 percent in Brazil.17 This high labor transition, rising in China at the Mexico, the per student ratio of informality pulls down productivity household level from 4 percent in government spending on tertiary growth, deprives governments of tax 1975 to 24 percent in 2000.19 Yet education to secondary education is revenue, and leaves workers highly savings rates in Latin America remain 2.6 to 1. In South Korea, the ratio is vulnerable, since they are under the chronically low, in part because of 19 precisely the reverse. It spends 2.8 radar of social insurance systems. It is lingering fears of hyperinflation. times more per student on secondary also a key reason why inequality, as However much they save, developing than tertiary education.16 The tilt in measured by the GINI coefficient, economies need efficient capital Latin America’s educational budgets remains so high across the region, markets to allocate their savings to the may perpetuate socioeconomic even in relatively faster-growing Chile. highest-return investments. Here Latin inequalities, especially as the market- America is making rapid progress, returns to skilled labor continue to Savings rates in Latin America thanks in part to the growth of its increase relative to the returns to remain chronically low. funded retirement systems. unskilled labor. Human capital is an essential If Latin America overcomes these All of this helps to explain the large ingredient in rising living standards, obstacles and permanently raises size of the informal sector in Latin but it is not the only ingredient. the growth path of its economies, America. Business and labor-market Developing economies need to the old-age dependency challenge will regulations impede the creation of invest heavily in R&D if they are to become much less daunting. By the formal-sector jobs, while inadequate move up the global value-added same token, as we will see in the next human capital development means scale. According to the Inter-American chapter, the right kinds of retirement that workers do not have the skills to Development Bank, South Korea alone policies can help Latin America meet fill them. Across the region, the size spent more on R&D in 2002 than all of its development challenge. of the informal labor market ranges Latin America.18 Developing economies from one-third to two-thirds of total also need adequate savings to fund

16 World Development Indicators 2008, The World Bank, April 2008, http://www.worldbank.org. 17 Data refer to 2003 for Chile and to 2005 for Brazil and Mexico. See Socio-Economic Database for Latin America and the Caribbean, CEDLAS and The World Bank, http://www.depeco.econo.unlp.edu.ar/cedlas/sedlac. 18 Education, Science and Technology in Latin America and the Caribbean: A Statistical Compendium of Indicators (Washington, DC: Inter-American Development Bank, 2006), 38. 19 Franco Modigliani and Shi Larry Cao, “The Chinese Saving Puzzle and the Life-Cycle Hypothesis,” Journal of Economic Literature 42, no. 1 (March 2004), 147. revolution CHAPTER 2

Latin America’s Pension Revolution revolutionOver the past 25 years, Latin America has been swept by a wave of pension reform. Chile led the way in the early 1980s when it closed its pay-as-you-go public pension system, which was careening toward bankruptcy, and replaced it with a system of fully funded personal retirement accounts. Since the early 1990s, nine other countries have also initiated partial or complete transitions to personal accounts systems.

The new systems vary considerably in design. Some countries, following Chile’s example, have entirely replaced their pay-as-you-go public pension systems (Bolivia, El Salvador, and Mexico). Some maintain parallel pay-as-you- go and funded systems that workers must choose between (Colombia and Peru). And some (Costa Rica and Uruguay) have “mixed systems” that include a pay-as-you-go tier that covers all workers and an additional funded tier for higher-earning workers. Argentina, until it shut down its personal accounts system in November 2008, had a unique arrangement: a first tier consisting of a pay-as-you-go flat benefit plus a second tier that offered workers 21 a choice between a pay-as-you-go earnings-related benefit and a personal account. Among the major Latin American countries, only Brazil, Ecuador, Venezuela, and (now) Argentina have purely pay-as-you-go public pension systems. Brazil, however, has a large voluntary funded system of “complementary” private pensions.

In this chapter, we first discuss the potential advantages of funded pension systems in an aging Latin America. We then examine some of the critical areas in which these systems are—or are not—living up to their promise.

The Advantages of Funded Pensions

Latin America’s personal accounts against undue market risk while they pension systems are often referred are contributing workers and against to as “privatized” systems. The term, longevity risk when they are however, is misleading. Although retired—that is, against the risk of worker contributions are managed outliving their assets. Most also and invested by private pension come with a minimum pension fund managers, the systems guarantee that provides a subsidized are mandatory public pension floor of retirement income protection systems, or in some cases optional to lifetime low earners, and so components of mandatory public retain some of the redistributive systems. They operate under strict features included in many public regulatory guidelines designed to pay-as-you-go defined-benefit protect participants or “affiliates” schemes. Latin America’s funded to contributions paid in, at least for Any retirement system needs pension systems have decisive higher-earning workers who do not a robust floor of protection. advantages over pay-as-you-go qualify for a minimum pension systems. guarantee, workers may be less likely All of this helps to explain the rapid to view their contributions as a tax. diffusion of the personal accounts Funded pension systems have Many of the original personal accounts model in Latin America. Whether the potentially decisive advantages over advocates in the 1980s and 1990s benefits of reform are actually realized, pay-as-you-go systems. In pay-as-you- believed that these incentives might be however, depends on how the systems go systems, a falling support ratio of especially important in Latin American are designed and implemented. contributing workers to retired countries, where trust in government Excessive administrative fees can 22 beneficiaries translates directly into a has historically been low, informal erode workers’ account balances, rising cost rate and contribution rate. labor markets large, and tax while overly restrictive investment Funded systems, on the other hand, compliance difficult to enforce. policies can reduce rates of return and can free countries from the tyranny of limit the positive impact on capital There are other potential advantages their own demography. While the markets. Contribution rates must as well. In the near term, funded long-term rate of return that workers also be set at an adequate level to pension systems can help to speed the can earn in a pay-as-you-go system is generate an adequate replacement development of Latin America’s capital limited to the rate of economic rate. Any retirement system, moreover, markets. In many developed countries, growth, the rate of return in a fully whether pay-as-you-go or funded, including the United States, funded funded system is equal to the rate also needs a robust floor of protection pensions have played a crucial role in of return to capital, which is typically for those who arrive in old age with broadening and deepening capital much higher, especially in aging an inadequate pension or no markets. As pension funds grow, so societies with slowly growing pension at all. do the size and liquidity of capital workforces. Funded systems can markets. Along with professional Crucially, there is also the question of thus offer participants higher benefits fund management come greater how the transition from an existing at any given contribution rate than accountability, transparency, and pay-as-you-go system to a new pay-as-you-go systems can. long-term returns. In the long term, funded system is financed, since Funded pension systems may funded pension systems can help to this determines the impact on fiscal also improve incentives for workers maintain adequate rates of savings balances and national savings. As to contribute, and thus broaden and investment, which is already a worker contributions are diverted coverage. Because account balances challenge in Latin America today and to the new personal accounts, the are personally owned and because will become even more difficult as its government must continue to pay the benefits paid out are proportional populations age. benefits of current retirees as well as the benefits already accrued by current are unsustainably high. But even whereas in a pay-as-you-go system a workers when they retire. If the new assuming more realistic rates of return, 75 percent replacement rate would, by private savings accumulating within Latin America’s personal accounts 2050, inflict a catastrophic 27 percent personal accounts is offset by an equal systems will be able to deliver payroll tax burden on workers. increase in government debt, the equivalent benefits at a much lower (See figures 9a and 9b.) macro benefits of reform may not cost than pay-as-you-go systems materialize. Public pension spending could—or, alternatively, much higher Latin America’s funded may decline, but long-term debt benefits at the same cost. pension systems will be able service costs will grow. At the macro to deliver higher benefits at a Consider an illustration. In Chile, level, the reform may be a wash— lower cost than pay-as-you-go the net contribution rate to the arguably leaving society as a whole systems can. personal accounts system—that is, the 23 no better off. rate after subtracting administrative These illustrative projections may A Personal Accounts Report Card fees—is 10 percent of covered wages. understate the relative advantage of At a 5 percent real rate of return, a The central goal of any pension funded pension systems in most Latin reasonable long-term assumption for system is to provide adequate benefits American countries. They assume a a global portfolio of stocks and bonds, for retirees. Although Latin America’s 2.0 percent real wage growth rate— a full-career worker entering the personal accounts systems are still too which is about the average for Chile workforce in 2010, contributing new to evaluate their track record on over the past 25 years, but is at least 10 percent of wages for 40 years, this crucial measure of success, there double the average for most countries. and retiring in 2050 would earn a is little doubt they will outperform The lower the rate of real wage replacement rate of 60 percent. pay-as-you-go systems—at least for growth is, the greater is the advantage To finance the same benefit on a workers who contribute regularly. of funded systems over pay-as-you-go pay-as-you-go basis, his or her Between the establishment of Chile’s systems. If real wages were to grow at contribution rate would, as Chile’s personal accounts system in 1981 and 1.0 percent per year in the future, the population ages, have to rise to 22 December 2007, the real rate of return same full-career worker would earn a percent by 2050. A 60 percent on worker contributions averaged 10.0 75 percent replacement rate with his replacement rate may not be adequate percent. Between the establishment of or her 10 percent contribution rate. A unless a retiree has other sources of Mexico’s system in 1997 and 12.5 percent contribution rate would income. But if society desires greater December 2007, the real rate of return generate a 95 percent replacement adequacy, it could raise the worker’s averaged 7.3 percent. Admittedly, rate. To be sure, real rates of return replacement rate to 75 percent with these returns were inflated by heavy might be lower in the future than the a 12.5 percent contribution rate, investment in high-risk public debt and 5.0 percent we assume, and this Funded pension systems have a decisive cost advantage in an aging society. Required Pay-As-You-Go versus Funded Contribution Rates* in Chile: 60 Percent Replacement Rate 9a 30%

25%

20% l l o r y a

P 15%

e l b a

would push the other way. But in x a T

f o

t

almost any reasonable scenario, n

e 10% c r e the funded system would deliver a P PAYGO higher replacement rate at the same 5% Funded contribution rate as a pay-as-you-go system. In fact, real returns would 0% 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 have to sink beneath 3.0 percent, what many economists consider the long-term risk-free rate of return, Required Pay-As-You-Go versus Funded Contribution Rates* in Chile: for the funded system to lose its 9b 75 Percent Replacement Rate 30% 24 relative advantage.

The replacement rates that personal 25% accounts systems can generate are of

course affected by administrative fees. 20% According to one well-known study, l l o r y

a 15% the administrative fees charged by P

e l b a x

Latin American pension funds reduce a T

f o

t

n 10% eventual account balances—and e c r e P hence replacement rates—by as PAYGO much as 15 to 25 percent beneath 5% Funded what they otherwise would be.20 High 0% administrative fees are a legitimate 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 concern, and reducing them has * PAYGO calculations assume 2.0 percent real wage growth, universal coverage, and a retirement age of 65: become a central goal of government personal account calculations assume 2.0 percent real wage growth, a 5.0 percent real rate of return, a 40-year career, and a retirement age of 65. regulation and reform. Some countries Source: UN (2007) and CSIS calculations have capped fees. Others are relying more on competition—for instance, by standardizing fee structures to improve who fail to choose a fund to the fund in Mexico they have dropped by 50 transparency and facilitate comparison with the lowest fees (Chile) or the percent between 2000 and 2007. between funds, by allowing workers highest net return (Mexico). Average Latin America’s personal accounts to switch more frequently between fees (measured as a share of wages) systems have been less successful at funds, or by assigning new affiliates are now falling in most countries, and delivering high rates of pension

20 Edward Whitehouse, “Administrative Charges for Funded Pensions: An International Comparison and Assessment,” Social Protection Discussion Paper no. 0016 (Washington, DC: The World Bank, June 2000). coverage than high rates of return. countries, moreover, have exempted Not surprisingly, the low coverage Coverage in some countries has risen significant parts of the labor force problem is especially serious among significantly since reform, suggesting from mandatory coverage—for low-wage earners. In Brazil, for that incentives may indeed matter. instance, self-employed workers in example, the active contributor rate Yet everywhere, it remains far from Chile. The biggest problem, however, in 2002 was 17 percent for the lowest universal. In Chile, the share of the is the large size of Latin America’s income quintile, but 67 percent for the workforce that contributes to the informal labor markets, which highest income quintile. In Mexico, pension system each year jumped have proven more of an obstacle to the rate was 10 percent for the lowest from 42 percent in 1982, just after boosting coverage than many reform quintile, but 56 percent for the its reform was implemented, to 64 advocates anticipated. highest. The differential is not as wide percent in 2006. In Mexico, the share in Chile, though even there the active 25 rose slightly after its reform in 1997, Low coverage rates remain contributor rate for the lowest quintile but now appears to have plateaued at a serious problem throughout is much lower than for the highest— a low level—just 38 percent in 2006, Latin America, regardless of 40 percent versus 70 percent in 2003.22 even including contributors to the the type of pension system. (See figure 10.) Clearly, it will be diffi- separate civil service pension system. cult to improve coverage so long as Low coverage thus remains a problem It is true that rates of pension system widespread poverty and large informal throughout Latin America, regardless “affiliation” are generally much higher sectors coexist. of the type of pension system. During than active contributor rates. the late 1990s and early 2000s, What all of this underscores is the But the number of affiliates merely the active contributor rate averaged importance of a robust floor of refers to the number of workers with a less than 30 percent in eight Latin protection. Although most personal personal account. Many affiliates American countries (half with personal accounts and pay-as-you-go pension do not contribute regularly, which accounts systems and half with systems in Latin America have means that many will arrive in old pay-as-you-go systems). In four minimum pension guarantees that age with low benefits despite high countries, it averaged between provide a poverty backstop, the rates of return. 30 percent and 50 percent—a group guarantees do nothing to help those Part of the explanation may lie in that includes reformers Argentina and workers who do not contribute at all. the design of the pension systems Mexico as well as nonreformers Brazil In fact, since eligibility for the themselves. The minimum benefit and Venezuela. Only Chile, Costa Rica, minimum guarantees generally guarantees in some systems may and Uruguay—all reformers—had requires many years of contributions weaken incentives for low-wage contributor rates of over 50 percent.21 (20 years in Chile and 25 in Mexico), earners to contribute regularly. Some even many low earners who do

21 Rafael Rofman and Leonardo Lucchetti, “Pension Systems in Latin America: Concepts and Measurements of Coverage,” Social Protection Discussion Paper no. 0616 (Washington, DC: The World Bank, November 2006). 22 Ibid. Pension coverage in Latin America is highly skewed by income. Active Pension System Contributors, by Quintile and Total, as a Percent of 10 Labor Force in Most Recent Year* 80% 1Q 5Q Total 70% 70% 67% 64% e

c 60% r 56% o F

r

o 50% b a

L 41% 40% f 40% 38% o

t n

contribute to the pension system will e

c 30% r e

not do so long enough to qualify for P a subsidized benefit. 20% 17% 10% The better solution is a 10%

noncontributory floor of protection 0% paid for through general revenues. Brazil Chile Mexico *Data for totals refer to 2006 for Brazil and Chile and 2007 for Mexico; data for quintiles refer to 2002–2004. The floor can either be a universal flat Source: AIOS (2007); MPS (2007a); and Rofman and Lucchetti (2006) benefit or a means-tested benefit, though the former is much more funded pension systems is contributing To be sure, restrictive investment rules expensive. A few countries have significantly to the development of have blunted the positive impact. 26 universal noncontributory flat benefits, Latin America’s capital markets. The Initially, regulations in all countries including Bolivia and Brazil (for rural systems have given an enormous boost required most pension assets to be elders). Many countries have small to domestic bond markets, particularly invested in government debt. The means-tested benefits for indigent government bond markets, lengthening requirement was partly due to the elders. Any noncontributory floor of maturities and spurring the introduction conservative investment philosophy of protection, of course, may further of new securities like inflation-indexed the pension regulators, partly to undermine incentives to contribute to bonds in Mexico and tradable secure a captive source of financing the regular pension system. Chile has recognition bonds in Chile. They for the transition, and partly because tried to address the problem with its have helped to increase stock market adequate alternative investment new “solidarity pensions,” which capitalization, though in most countries options were not always available. (as we will see) are means-tested markets still remain illiquid and highly As capital markets have developed, but explicitly integrated with the concentrated. Insurance markets have however, the regulations have been contributory pension system in a way also grown as a result of pension liberalized and portfolios progressively that attempts to preserve incentives reform, since in most countries with diversified in most countries. A few for workers to contribute. personal accounts systems pension countries, notably Chile and Peru, are fund managers are required to clearly moving in the direction of Funded pension systems purchase survivors and disability “prudent man” investment rules. are speeding the development insurance for affiliates. There have Overinvestment in government debt, of Latin America’s capital been other benefits as well: broader however, still remains a cause for markets. mortgage bond markets, better credit concern in some countries, including As for the macro benefits of reform, rating agencies, and improved Mexico. (See figure 11.) there is no question that the creation of corporate governance. Some pension systems are rapidly diversifying while others remain heavily invested in government debt. Portfolio Composition of Pension Funds in December 2007 11

100%

90% Other s t e

s 80%

s Foreign Securities A

l 70% a

t Mutual & Investment o

T Funds

60% f o

t 50% Equities n e c r 40% Non-Financial Institutions

e mid-1980s and will continue to do so P 30% Bank Deposits in decades to come. At the same time,

20% Government Debt the government has been running 10% large budget surpluses that have offset

0% lost revenue as pension contributions Mexico Brazil* Chile were diverted to the personal

*Closed funds; data are for August 2008. accounts. The Chilean experience, Source: AIOS (2007) and ABRAPP (2008) however, has not been repeated in other countries, where reforms have Restrictions on foreign in creating jobs, building housing, or been largely debt-financed. investment need to be improving public infrastructure at Leveraging the full macro benefits of 27 gradually lifted. home—especially in view of the reform will require fiscal discipline that tax incentives that pension savings many Latin American countries now Despite the trend toward portfolio receives. But in the end, restrictions lack. This failing, of course, is by no diversification, most countries still on foreign investment, like means unique to Latin America. The maintain low limits on foreign requirements to load portfolios with United States has been accumulating investment, Chile being the only government debt, undermine the a large Social Security trust-fund major exception. While these limits primary purpose of any funded surplus that is supposed to partially may seem prudent in the midst of pension system—which is to earn prefund the retirement of its baby today’s global market meltdown, they the highest risk-adjusted return boom generation, but has cancelled pose a serious long-term problem. for participants. Although Latin American capital out the boost to national savings by markets are broadening and Except in Chile, reforms have running larger deficits in the rest of deepening, the growth in failed to raise national savings. the federal budget. The fact remains, pension fund assets is outpacing however, that funded pension systems domestic investment opportunities. While the impact of personal accounts have the potential to raise national To be sure, there are some legitimate reforms on Latin America’s capital savings, whereas pay-as-you-go arguments for the limits on foreign markets has been uniformly positive, systems are sure to lead to rising investment. Savings sent abroad does the impact on national savings has contribution rates, rising fiscal costs, not increase the domestic capital stock not. In Chile, the reform appears to and lower national savings as societies or worker productivity. Governments have boosted national savings and age. Either that, or benefits will have 23 maintain, with some justification, that consequently investment and growth. to be cut, undermining the pension the money should instead be invested Government pension spending has system’s adequacy. been declining steadily since the

23 See, for example, Vittorio Corbo and Klaus Schmidt-Hebbel, “Macroeconomic Effects of Pension Reform in Chile,” in International Federation of Pension Fund Administrators (FIAP), ed., Pension Reform: Results and Challenges (Santiago: FIAP, 2003); and Andrew A. Samwick, “Is Pension Reform Conducive to Higher Saving?” The Review of Economics and Statistics 82, no. 2 (May 2000). Retirement Reformreformin Chile, Mexico, and Brazil CHAPTER 3

m in Chile, Mexico, and Brazil reformMost Latin American countries have made significant progress in building adequate and sustainable retirement systems that will help them confront their coming age waves. The progress, however, varies considerably across the region—and across the three countries featured in this report.

Chile, which launched Latin America’s first personal accounts system in 1981, may be the best prepared of all countries in the region to meet the challenge. The fiscal costs of its old pay-as-you-go pension system are steadily declining and funded pension assets have already reached impressive levels as a share of GDP. In recent years, the failure of Chile’s personal accounts system to achieve universal coverage has raised serious concerns about its ability to provide adequate benefits to all retirees. A major “reform of the reform” in 2008, however, greatly strengthened the system’s adequacy while preserving—or even enhancing—its strengths. 29 The outlook in Mexico is less certain. funded pension system, Mexico will Mexico established a personal also need to build a robust floor of accounts system in 1997, modeled poverty protection. on Chile’s, that helps to lay the Brazil faces a daunting long-term foundations for long-term retirement challenge. In contrast to Mexico, security. Pension liabilities are Brazil has among the highest rates relatively small and funded pension of elderly pension receipt and assets are growing rapidly. The among the lowest elderly poverty pension system, however, only rates in Latin America. But as its effectively covers a small fraction population ages, its expensive of the population. Mexico has the pay-as-you-go pension system will lowest rate of elderly pension receipt threaten to place an unsustainable among the three countries featured burden on the budget and economy. in this report and the highest rate of Either that, or Brazil will have to elderly poverty. Most elders still make deep cuts in benefits that depend on the extended family jeopardize the system’s adequacy. for support in old age—and with To escape this zero-sum dilemma, fewer than two in five workers we recommend that Brazil initiate contributing regularly to the public a partial transition to a funded pension system, the situation of personal accounts system— tomorrow’s elders may remain and outline a plan that would precarious. While strengthening its allow it to do so. chileChile neoclassical economics at the mandatory contribution rate was set University of Chicago. at 10 percent of monthly wages up On the eve of its pioneering to a cap, plus premiums for survivors reform, Chile’s pension system was Ninety-five percent of and disability insurance and in shambles—institutionally prereform workers in administrative fees. Workers were fragmented, inequitable, and Chile switched to its new also allowed to make additional extremely expensive. Founded in personal accounts system. tax-favored voluntary contributions the early 1920s, it had morphed by to their main retirement account or the late 1970s into a byzantine The pension reform closed the old to a separate voluntary account. patchwork of 32 pension funds pay-as-you-go system to new 30 (called cajas), with over a hundred entrants and replaced it with a In a model followed by all different schemes that varied widely mandatory system of fully funded subsequent Latin American personal from sector to sector in eligibility personal retirement accounts. accounts reforms, participating rules and benefit levels. Financially, Current workers at the time of the workers, or affiliates, choose the system was plagued by high reform were given a choice of among a selection of competing payroll tax rates, widespread evasion, remaining in the old system or pension fund managers, which in and yawning deficits. Between 1960 switching to the new system. Those Chile are called Administradores de and 1980, the ratio of contributors who switched received “recognition Fondos de Pensiones (AFPs). The to beneficiaries plunged from 10.8 bonds” equal to their accrued pension system is supervised by a to 2.2, pushing the system to the benefits that were deposited in special government regulatory brink of collapse.24 their personal accounts and payable agency, which, among other functions, certifies the AFPs and Although there had been previous upon retirement. Over a million sets investment guidelines. Although attempts at reform, it was not until workers switched in the first year, the guidelines initially required most the rule of General Pinochet that and 95 percent of all prereform 25 assets to be invested in government the pension system was finally workers eventually did so. The debt or bank deposits, they have overhauled. The Pinochet new system in principle covered been progressively liberalized. As of government’s “privatization” plan, the entire workforce, except for December 2007, 26 percent of assets the first such in the world, was part the self-employed, for whom were in private domestic securities of a larger macroeconomic reform participation was optional, and and mutual funds and 36 percent in agenda instituted by the members of the armed forces foreign securities—far and away the “Chicago Boys”—economic and police, who remained under a largest foreign investment share of advisers who had been trained in separate pay-as-you-go system. The

24 The Chilean Pension System, Fourth Edition (Santiago: Superintendency of Pension Fund Administrators, 2003), 37. 25 Mauricio Soto, “The Chilean Pension Reform: 25 Years Later,” Pensions: An International Journal 12, no. 2 (March 2007), 101. any Latin American pension system. rising pension costs, boost worker positive, mainly because the Originally, AFPs were required to place replacement rates, and, along the government offset revenue losses all of their affiliates in the same invest- way, help to foster the development during the transition by running ment fund. In 2002, however, Chile of Chile’s capital markets and fuel large budget surpluses. There is no switched to a multifund model. Each economic growth. By linking benefits question about the positive impact AFP can now offer five fund choices more tightly to contributions and by on capital market development. with varying levels of risk. Affiliates offering the security of personal Chile’s pension funds have exploded who fail to choose are assigned to a ownership of retirement assets, they in value from 1 percent of GDP in fund based on their age. also hoped that the reform would 1981 to 64 percent in 2007, increase participation in the pension broadening and deepening capital The original reform also provided 31 system and thus, in the long run, markets. Although it is difficult to for two separate poverty backstops. reduce old-age poverty. separate the impact of Chile’s Affiliates who contribute to their pension reform from its overall personal accounts for at least 20 Chile’s pension funds market reform agenda, some studies years and whose account value at have exploded from 1 percent conclude that it has contributed retirement is below a minimum to 64 percent of GDP since significantly to Chile’s strong growth threshold were entitled to a its 1981 reform. performance over the past 25 years.27 government-financed “top up” benefit called the minimum pension At the macro level, the pension As we have seen, the system has also guarantee. There was also a small system’s success has been impressive. generated high real rates of return, noncontributory means-tested Pension spending has been falling which means that replacement rates benefit known as PASIS, worth about steadily as a share of GDP, from well will also be substantial—at least for half the minimum pension, for elders over 6.0 percent in the mid-1980s to workers who contribute for a full who either fail to contribute for 20 just under 3.0 percent today. The career. Yet over the past decade, years or were never in the system government projects that it will there has been growing concern that at all. As we will see, this original continue to fall in the future, the system will leave many Chileans poverty floor was fundamentally dropping to 1.6 percent of GDP by —perhaps most—with inadequate restructured by a major new reform the mid-2020s, when the transition benefits in old age. Although the that went into effect in 2008. will be largely complete.26 Although active contributor rate has risen over the past 25 years and is now The reform’s architects hoped that the impact on national savings is among the highest in Latin America, it would reduce the fiscal burden of difficult to measure, many studies have concluded that it has been it was still just 64 percent in 2006.

26 Consejo Asesor Presidencial para la Reforma Previsional, El derecho a una vida digna en la vejez: Hacia un contrato social con la previsión en Chile (Santiago: Presidencia de la República de Chile, July 2006), Annex 4. 27 See, for example, Vittorio Corbo and Klaus Schmidt-Hebbel, “Macroeconomic Effects of Pension Reform in Chile,” in International Federation of Pension Fund Administrators (FIAP), ed., Pension Reform: Results and Challenges (Santiago: FIAP, 2003). The problem is that, though most less agreement on what shape the pension if they havemexico no contributory Chileans contribute to the system at reform should take.29 Initially, there pension benefit. Elders with a some point in their work lives, only was much speculation that the victor contributory pension who meet the a minority contribute regularly. The from the center-left Concertación income test will still be eligible for a structure of the minimum pension coalition, Michelle Bachelet, might solidarity pension, but it will be guarantee may have added to the roll back the personal accounts reduced by roughly one peso for problem by reducing incentives for system. Instead, following the every three pesos in contributory low-wage workers to contribute recommendations of her Advisory benefits. Under the old system, at the margin. Most of the Commission on Pension Reform— low-earning workers had little coverage problem, however, lies better known as the Marcel incentive to contribute once they 32 in the structure of Chile’s labor Commission after its chairman, Mario qualified for the minimum pension market, with its high levels of Marcel—the Bachelet government guarantee. Under the new system, self-employment and informality. backed a well-crafted reform plan each extra peso in contributions will that strengthened the personal always earn an extra return. In 2006, new projections based accounts system while creating a on actual worker contribution The reform includes other measures more robust floor of protection. histories confirmed that a large share designed to increase participation in of affiliates might indeed face Chile’s new “solidarity the system and improve its adequacy. 28 hardship in old age. A staggering pensions” provide a promising It makes participation by the 45 percent of affiliates would have model for other countries. self-employed mandatory, with pensions below the minimum the requirement to be phased in pension guarantee threshold, but The “reform of the reform,” over seven years; it seeks to boost would not have met the contribution which became law in 2008, the participation of young low-wage requirements to qualify for the created a new and more generous workers by paying subsidies to subsidized benefit. The affiliates at noncontributory “solidarity pension” employers who offer them the bottom end of the pension that replaces both the means-tested formal-sector jobs; and it distribution were mostly female, PASIS benefit and the minimum supplements the accounts of low-wage, or irregularly employed. pension guarantee. When the reform women to compensate them for time spent as noncontributors while By the 2006 presidential election, is fully phased in in 2012, elders at home raising children. there was broad consensus that the with family incomes of less than pension system once again needed 60 percent of the national average At the same time, the reform serious retooling—though there was will be eligible for a full solidarity sought to improve the efficiency

28 Solange Berstein, Guillermo Larraín, and Francisco Pino, “Chilean Pension Reform: Coverage Facts and Policy Alternatives,” Economia 6, no. 2 (Spring 2006). 29 Larry Rohter, “Chile’s Candidates Agree to Agree on Pension Woes,” The New York Times, January 10, 2006. mexicoof the personal accounts system. It Voluntary Collective Pension Savings future unless Mexico strengthens its continues the process of gradually scheme (APVC) in which worker old-age safety net. Imagine, in liberalizing investment guidelines, contributions can be matched by Mexico’s cities, millions of today’s most notably by further raising the employer contributions. midlife adults aging by the 2030s ceiling on foreign investment. It also into millions of indigent elders who Chile’s “reform of the reform” includes a variety of measures aimed lack a pension or personal savings. has succeeded in improving the at enhancing competition and Or imagine, in the countryside, pension system’s adequacy without reducing fees. These include: millions of demographically stranded undermining its efficiency—and so standardizing and streamlining the elders without nearby children to leaves Chile better positioned than system’s commission structure by support them. Looking ahead, the ever to confront the age wave. It is 33 requiring AFPs to charge a single late Mexico scholar Delal Baer doubtful, however, whether the new monthly percentage-of-earnings fee; warned of a “social catastrophe” incentives and subsidies will alone assigning new affiliates who fail to in Mexico’s future if it fails to dramatically raise the share of the choose an AFP to the AFP with the prepare for its age wave.31 workforce that contributes regularly lowest commissions; and setting up to the pension system. Ultimately, Mexico in fact took an important an educational fund that will be broad retirement security will depend step toward meeting the aging used to improve the financial on Chile’s success in reducing challenge in 1997, when the literacy of affiliates. inequality and increasing the size government of Ernesto Zedillo While strengthening the mandatory of its formal sector—that is, on the replaced its old pay-as-you-go system, the reform also created success of its broader development pension system for private-sector new incentives to contribute to agenda. Yet here too there is workers, which was plagued by the pension system’s voluntary reason for optimism, since Chile widespread evasion and spiraling component, where participation has has long been a regional leader payroll tax rates, with a new system been low. As of June 2008, there in economic development as well of funded personal retirement were just 1.6 million voluntary as pension reform. accounts. Mexico’s personal accounts pension accounts, compared with system shares much in common Mexico 8 million mandatory accounts—and with the original Chilean system. of these 45 percent were empty.30 Nearly one in three Mexican elders Workers choose among competing To encourage voluntary savings, the now live beneath the World Bank’s pension funds, known as reform provided for additional tax poverty threshold of two dollars a Administradoras de Fondos para incentives and created a new day—a share that could rise in the el Retiro, or AFOREs. Participation

30 Boletín Estadístico, no. 204 (Santiago: Centro de Estadísticas de la Superintendencia de Pensiones de Chile, 2008). 31 M. Delal Baer, “Mexico at Impasse,” Foreign Affairs 83, no.1 (January/February 2004). by the self-employed is voluntary. Eighty-five percent of 85 percent of affiliates contribute And there is a minimum pension affiliates in Mexico contribute less than 50 percent of the time, few guarantee, equal to the minimum to the pension system less will satisfy the 25-year contribution wage, for workers who contribute than half the time. requirement to qualify for the for 25 years. minimum pension guarantee.32 While Mexico’s new pension system Mexico, in other words, is in the But Mexico’s system also differs in helps position it to confront the age same situation in which Chile found critical ways. At just 6.5 percent of wave, its benefits are inadequate. itself before its “reform of the covered wages, the contribution rate After administrative fees, the net reform”: Many workers will need is lower than in Chile—though the contribution rate for an average- the minimum pension guarantee, government also makes an additional 34 earning worker, including the social but only a small minority will flat contribution, known as the quota, was just 7.3 percent in 2006. qualify for it. “social quota,” to each worker’s Even over a full 40-year career, this account. There is no noncontributory At the same time, Mexico is failing may only be enough (assuming a pension, except for a small benefit to realize the full macro benefits of 5.0 percent real rate of return) to for indigent elders aged 70 and reform. To begin with, the life-switch generate a replacement rate of 40 over in certain rural communities. option, for which the great majority percent. To be sure, the social quota, All current workers at the time of of transition generation retirees will which equals 5.5 percent of the (real reform were transferred to the qualify, leaves taxpayers on the 1997) minimum wage, boosts the personal accounts system, but hook for the old system’s unfunded net contribution rate for low earners, received a “life-switch” option that liabilities. Since the old system only raising it all the way to 11 percent guarantees them the benefit they covered a fraction of the workforce, for minimum wage workers. But would have received under the old this alone may not be a large fiscal since very few low-wage workers system if, at retirement, that benefit burden. But the government will also contribute regularly, very few will is larger than their personal account have to top-up the accounts of earn adequate benefits, despite the benefit. Civil servants, employees of future retirees who qualify for the generous government match. PEMEX, Mexico’s oil giant, and a few minimum pension—and, just as the According to one projection, over other groups were exempted from Chilean government did, it will surely half of affiliates will need to have the reform and allowed to remain come under pressure to cover the their account balances topped-up in their own separate (and costly) much larger number who fall below to reach the minimum pension level. pay-as-you-go systems. the minimum pension level but Yet given the fact that more than fail to qualify for the guarantee.

32 Tapen Sinha and Maria de los Angeles Yañez, “A Decade of Government-Mandated Privately Run Pensions in Mexico: What Have We Learned?” in Stephen K. Kay and Tapen Sinha, eds., Lessons from Pension Reform in the Americas (New York: Oxford University Press Inc., 2008). According to Mexican pension accounts, and the AFOREs then lend Mexico’s 2007 reform expert Tapen Sinha, “The new the money to the government, which may boost long-term returns system might not save much money uses it to pay pension benefits owed and replacement rates. in the long run, and in fact may turn under the old system. out to be more expensive.”33 The same year, the government of A major reform enacted in 2007 Felipe Calderón also tackled reform may help to boost long-term returns Mexico’s pension of the civil service pension system, and replacement rates. The reform funds are still overinvested which had long been a third rail allows further diversification of in government debt. of Mexican politics. The system, pension portfolios by raising the which offers participants outsized ceiling on equity investments and by The system’s original investment replacement rates at early retirement 35 introducing multifunds like those in rules were also highly restrictive, ages, was forecast to run ever- Chile. It also overhauled the system’s channeling virtually all contributions widening deficits. The reform closed complex fee structure. Originally, into public debt. Over the past few the existing pay-as-you-go system each AFORE had considerable years, the rules have been gradually to new hires and opened a new latitude to design its own structure, relaxed. Investment in domestic personal accounts system. Unlike with charges on contributions, equities has been allowed since private-sector workers under the charges on assets under 2002, and foreign investment has 1997 reform, prereform public- management, or a combination of been allowed since 2004. But as of sector workers can choose to remain the two. The reform limits AFOREs December 2007, 69 percent of total in the old pay-as-you-go system— to a single charge on account pension fund assets were still in though they will face higher balances. To facilitate cost government debt, compared with retirement ages if they do. Although comparisons by affiliates, it also just 8 percent in Chile. Although civil servants will initially contribute introduced a net-rate-of-return surging demand by the AFOREs has to a special government-run fund indicator that tracks the performance helped fuel the rapid development called PensionISSSTE, after 2010 they of AFOREs over the previous 36 of Mexico’s bond markets, the will be able to join the AFORE of months. All new affiliates who fail restrictions have so far retarded the their choice. Only a tiny fraction of to choose a fund are automatically impact on equity markets. They prereform workers have switched, assigned to the AFORE with the have also undermined the potential however, which means that the highest net rate of return. savings boost of the reform. In effect, pay-as-you-go system will endure for workers contribute to their personal many decades to come.

33 Ibid., 284. The inadequacy ofbrazil the funds purchase survivors and regime, or RPPS, for federal and state benefits offered by Mexico’s disability insurance for their affiliates civil servants. The combined cost of pension system remains a at much lower cost—an average of the two regimes totaled 11.4 percent pressing concern. just 1.0 percent of payroll in Chile. of GDP in 2006—more than many developed countries with much older At the same time, Mexico must build While recent reforms have pushed age structures spend on their public a floor of old-age income protection. Mexico’s pension system in the right pension systems. Just one in five elders now receive direction, the inadequacy of its a pension benefit—and given the The rising fiscal burden of Brazil’s benefits remains a pressing concern. current low active contributor rate public pension system has long been a The personal accounts system’s low this share may not rise much in major policy concern. Payroll tax rates 36 basic contribution rate clearly needs the future. Yet despite the greater are high—20 percent for employers to be raised. One way to do this vulnerability of its elders, Mexico has and 8 to 11 percent for workers in the without imposing a new burden no broad floor of old-age poverty private-sector RGPS regime, depending on workers would be to shift the protection. Rather than a minimum on their wage level. Yet despite the additional 5 percent contribution that pension guarantee for which only a high payroll tax rates, the pension they now make to a government-run minority of workers will qualify, system is running large deficits. housing fund (known as INFONAVIT) Mexico needs to introduce a Reform has been difficult, in part to their personal retirement accounts. noncontributory pension along the because most of Brazil’s basic pension As it is, contributions to the housing lines of Chile’s solidarity pensions. An provisions were written into its 1988 fund earn a low administratively adequate system would come with a constitution, which means that determined rate of return and often significant price tag. But this is a cost legislating any significant change in go unused. Another way to raise the that Mexico will ultimately have to the rules requires commanding a contribution rate—or more precisely, bear one way or the other. three-fifths majority in the Chamber the net contribution rate—would of Deputies. be to restructure Mexico’s costly Brazil survivors and disability insurance Unlike Chile and Mexico, Brazil retains Prior to the 1998 reform, system. In Mexico, these benefits are a purely pay-as-you-go public pension private-sector pensioners in financed on a pay-as-you-go basis system. There are two main regimes: Brazil received 100 percent with a 2.5 percent of payroll worker the general regime, or RGPS, for the replacement rates. contribution. In other Latin American private sector and the civil service personal accounts systems, pension Nonetheless, Brazil succeeded in age of the spouse, the length of the exceed the maximum private-sector enacting a significant reform of the marriage, or the presence of minors— benefit. For new civil servants, the private-sector regime in 1998. Prior provisions far more generous than reform went further. Benefits will be to the reform, pensions replaced 100 those in any developed country. calculated based on the same formula percent of a worker’s average earnings used for private-sector retirees and in the three years prior to retirement. Civil service pensioners maximum benefits will be set at the The reform cut the generosity of the in Brazil make up 13 percent same level. Over time, the reform will pension formula by switching the of all pensioners but receive gradually align the deals offered to base used in calculating benefits to 42 percent of all public public- and private-sector workers. career-average earnings. It also pension benefits. The process, however, will take a 37 introduced an “actuarial factor” half-century to complete. Meanwhile, a push to reform the (fator previdenciário) into the formula civil service regime began to gather As in other Latin American countries, that penalizes early retirement and momentum—not just because of the many workers fail to contribute to the indexes benefits to life expectancy. high cost of the RPPS, but because pension system. The active contributor Yet in most respects, the private-sector of the huge inequity in the system’s rate in Brazil was just 41 percent in regime remains very generous. Despite lavish benefit provisions. Civil service 2006, including both the private- and the cut, RGPS replacement rates pensions are so generous that even public-sector regimes. The share of remain relatively high. Workers can though civil service pensioners make elders who receive benefits, however, still retire at any age with a “seniority up just 13 percent of all Brazilian is far higher than the share of workers pension” if they have met the pensioners, they receive 42 percent who contribute, which helps to explain minimum contribution requirements of all public pension benefits.34 the system’s high cost and large (35 years for men and 30 years for deficit. At 92 percent, Brazil’s pension In 2003, the Lula government took women). Those who fail to meet receipt rate is only rivaled by a first step toward redressing the the requirements can collect benefits Argentina’s. Since 1988, there has imbalance. For civil servants already in at age 65 (for men) or age 60 been a noncontributory rural pension the system, the 2003 reform raised the (for women) with just 15 years of paid to elders aged 60 and over minimum retirement age from 53 to contributions. Survivors benefits, equal regardless of income. Since 1993, 60 for men and from 48 to 55 for to 100 percent of the deceased there has also been a means-tested women. It also imposed a surtax on worker’s retirement benefit, are pension for indigent elders aged civil service pension benefits that payable for life without regard to the 65 and over.

34 The data refer to 2003. See “Brazil: Programmatic Fiscal Reform Loan: Social Security Reform Project,” Program Document no. 32226-BR (Washington, DC: The World Bank, May 6, 2005), 9. Brazil has one of the will rise only marginally in the future, in the future. Under this hypothetical lowest elderly poverty rates from 7.2 percent of GDP in 2007 to “cost pressure” projection, the cost of in Latin America. 8.1 percent of GDP in 2040.35 the RGPS would rise to 16.7 percent These projections, however, are highly of GDP in 2040, more than double These special pensions have reduced optimistic. They assume that the today’s level. (See figure 12.) elderly poverty rates in Brazil to one minimum wage, and hence the Brazil thus finds itself on the horns of of the lowest levels in Latin America. minimum pension, will only be a dilemma. Controlling the long-term But they have also created adjusted for inflation in the future, cost of the RGPS will mean reducing disincentives to participate in the which means that its value will fall its benefits far beneath what most formal sector and contribute to the steadily relative to the average wage— Brazilians now expect it will provide. 38 regular pension system. Workers who thus reversing current policy. This On the one hand, these reductions are collect the noncontributory rural and assumption has a large impact on the sure to face growing public resistance. means-tested pensions receive benefits projections, since minimum pensions, On the other, if the reductions implied that are identical to the minimum which are received by two-thirds of by the government’s projections contributory pension they would all beneficiaries, now account for actually occur, the generosity of the receive if they had paid into the RGPS. 45 percent of all RGPS expenditures. system will eventually fall so far that The benefits, moreover, are all pegged The projections also assume that the it will come to be widely regarded as to Brazil’s generous minimum wage, ceiling on contributory wages will only inadequate. The only way out of the which has been rising rapidly in be indexed to prices, which means dilemma is for Brazil to rely less on real terms and as a share of that, over time, a progressively larger pay-as-you-go transfers and more on average wages. share of total wages will be over the funded retirement savings and the ceiling. This in turn means that bene- higher returns it can generate. As Brazil ages, its pension fits will replace a progressively smaller system threatens to become share of worker earnings. Brazil already has a voluntary system an even larger burden on the of “complementary” private pensions. To put the implications of the budget and economy. There are two types: open funds, in government projections in perspective, which any worker can participate; and As Brazil ages, its pension system we have calculated an alternative closed funds, which are generally threatens to become an even larger projection that assumes both the employment-based and restricted burden on the budget and economy. average RGPS retirement age and the to workers earning more than the To be sure, government projections average RGPS benefit relative to the RGPS contributory-wage ceiling. now show that the cost of the RGPS average wage will remain unchanged

35 Helmut Schwarzer, “Financiamento da Previdência Social” (presentation at the 4th meeting of the National Forum of Social Welfare [FNPS], Brasilia, April 24, 2007). Brazil’s pension system will come under intense cost pressure. 12 RGPS Pension Benefits as a Percent of GDP, 2007 and Projections for 2010–2040

18% 16.7%

P Government Projection 16% D CSIS “Cost Pressure” Projection* 15.0% G

14% 13.3% f o

12%

t 11.3% n

e 10% 9.6% c r 8.3% 8.0% 8.1%

e 7.8% 8% 7.2% 7.3% 7.3% 7.4% 7.5% 7.7% P 6%

4%

2%

0% 2007 2010 2015 2020 2025 2030 2035 2040

*The CSIS “cost pressure” projection assumes that both the average RGPS retirement age and the average RGPS benefit relative to the average wage will remain unchanged in the future. Source: MPS (2007b) and CSIS calculations

The combined assets of Brazil’s private To meet the aging challenge, Brazil Nonetheless, it is possible to design pension funds totaled an impressive 20 needs to broaden the share of the a fiscally responsible transition plan. 39 percent of GDP in 2006—more than in workforce that accumulates funded We outline a possible approach on the any Latin American country except for retirement savings. The best way to following two pages that would create Chile. Only a modest share of the do this is to gradually transform the a personal accounts component within workforce, however, contributes to the RGPS, at least in part, into a system the RGPS without raising the system’s funds—and most of the workers who of funded personal accounts. In the contribution rate or increasing its do contribute are higher earners. The 1990s, Brazil considered transitioning deficit. The reform would require restricted closed funds hold the lion’s to a funded personal accounts system, difficult political choices. But it share of assets (80 percent), but cover but rejected the idea because the would also bring considerable benefits. just 2 percent of the workforce. transition cost was deemed too large. Brazil’s current pension system has Participation in the complementary Although the 1998 reform has helped to lift millions of elders out of pension funds has up to now been reduced the system’s unfunded poverty and is widely viewed as a limited to private-sector workers. The liabilities, even a partial transition social success. The problem is that it 2003 reform of the civil service regime would still pose a daunting challenge. will not be sustainable as Brazil ages. provides for the creation of comple- The RGPS has no surplus that could It is time, while the window of mentary funds for new hires, but the be redirected to personal accounts. opportunity lasts, for Brazil to retool legislation is still pending. Indeed, as of 2006, it was running a the system so that it can continue deficit of 1.8 percent of GDP. Payroll to fulfill its vital mission. Brazil needs to broaden taxes are already high, which means the share of the workforce that jump-starting a funded system accumulating funded with an extra “add on” contribution retirement savings. is out of the question. A Personalpersonal Accounts System for Brazil accounts

The personal accounts system we shows that the people who would only flow to the personal propose would be organized and opt out of a voluntary system tend accounts to the extent that reforms implemented as follows. A public to be the people most in need later succeed in reducing the RGPS regulator would be created, which on. The accounts would also be deficit—or ultimately, creating would establish a personal account strictly regulated, with rules to a RGPS surplus. in each worker’s name. Initially, protect workers against both The worker RGPS contribution, 40 the accounts might be centrally investment risk and longevity risk. which amounts to about 10 percent administered by the regulator The guidelines for portfolio allocation of taxable payroll, currently accounts because all would be small and many could be modeled after those for for roughly one-third of total would be empty. But when account Brazil’s complementary closed funds. RGPS contributions and pays for balances reach some minimum Preretirement withdrawals would roughly one-quarter of total RGPS threshold, they would be transferred be prohibited and all assets would expenditures. To redirect half of to a certified private pension fund be transformed into monthly worker contributions to the personal manager of the worker’s choice, benefits upon retirement by accounts—the minimum reform or if the worker fails to choose, to means of a population-wide goal—would thus require finding the manager or managers with annuitization formula. savings equivalent to roughly the lowest administrative fees. The personal accounts would be 12.5 percent of RGPS expenditures. All contributions assigned by funded with part or all of workers’ default would be invested in lifecycle There are several ways to achieve current personal RGPS contributions. funds that adjust asset allocation savings of this magnitude without Simply carving out the contributions according to age. further reductions in the adequacy without accompanying cost-saving of RGPS retirement benefits beneath The plan would be mandatory, reforms would increase the RGPS those already scheduled in current because its benefits would constitute deficit, canceling out the new law. One way to generate near-term an important part of what Brazil personal accounts savings. The plan savings would be to tighten the deems to be an adequate retirement would therefore establish a strict eligibility rules and reduce the income—and because experience deficit-neutrality rule. Contributions generosity of survivors pensions, nal accounts

which accounted for 24 percent If larger accounts are desired, redirected as well. Since the size of of all RGPS expenditures in 2007. savings may have to be found that share would be determined by Reducing their generosity by outside the RGPS. One obvious the extent of the savings in the RGPS one-third would, over time, save source is the RPPS, which remains or RPPS, the plan is not only deficit 8 percent of expenditures. In the extraordinarily generous for any neutral, but would create a powerful longer term, significant savings worker who joined before 2003 political constituency behind ensuring could also be achieved by eliminating and will continue to be an outsized that the pay-as-you-go benefit 41 seniority pensions, which accounted burden on the budget for decades cuts actually occur. Workers would for 33 percent of RGPS expenditures to come. The plan provides that ultimately have their RGPS benefit in 2007. Recipients of these pensions savings from any additional reforms reduced actuarially to reflect their on average retire five years earlier to the RPPS be directed to the new smaller contribution to pay-as-you-go than other RGPS pensioners. If they personal accounts system. Over component of Brazil’s retirement retired at the same age, it would, time, these transfers might allow system. This in turn would generate over time, save another 7 percent the equivalent of the entire worker additional long-term savings. of RGPS expenditures. While a hike RGPS contribution to flow into The plan we have outlined in the retirement age obviously funded savings accounts. would help to ensure a more secure constitutes a cut in lifetime benefits, The reform plan would need to be retirement for tomorrow’s workers it does not reduce replacement rates phased in gradually in order to avoid as the generosity of today’s RGPS is or harm benefit adequacy. Higher explicit or implicit borrowing from inevitably reduced. Because the level retirement ages, moreover, would not the RGPS or RPPS. In the first few of personal accounts funding each only help finance the reform plan, years of the plan, only new workers year would depend directly on they would also be good for Brazil’s would have a share of their RGPS improvements in the balance economy, which will need to keep contributions redirected to their of Brazil’s pay-as-you-go pension older workers on the job longer as personal accounts. Over time, systems, it would also be much more its population ages and younger however, current workers would likely to raise national savings than workers become relatively scarce. have a share of their contributions a debt-financed transition plan. crossroads CONCLUSION

Latin America at a Crossroads crossroadsIf you take a stroll through Mexico City today, the odds that the next random person you meet will be elderly are just one in 16. Take the same stroll in 2050, and the odds will be one in five. By then, there will be more people in their 60s than in their 20s and more over age 80 than under age 5. How well Mexico—and the other Latin American countries now undergoing the same demographic transformation—prepare for their much older future will profoundly affect the dynamism of their economies and the mood of their societies. It could even determine whether they realize their aspiration of becoming affluent and fully developed economies.

By 2050, there will Fortunately, Latin America has be more Mexicans in their time to prepare for its coming 60s than 20s. age wave. As we have seen, the same demographic forces that will 43 Latin America’s success in meeting ultimately lead to the dramatic aging the aging challenge will depend as of its populations have now opened much on effective development up a window of opportunity for strategies as effective retirement economic growth and development policies. An aging Latin America that in most countries will last well will need broad and adequate and into the 2020s. secure retirement systems that can provide generous benefits for the old Latin America will need without imposing a heavy burden to build on its recent on the young. But this may not be economic progress. possible unless Latin America also raises the growth path of its Before the window closes, Latin economies, increases the size of America will need to build on its its formal sectors, and reduces recent economic progress. Countries today’s pervasive inequality. The will have to reform business and new challenge of supporting a labor-market policies that discourage much larger elderly population is participation in formal labor markets thus inextricably intertwined with and impair competitiveness. They will the broader economic and social have to raise chronically low rates challenges that have long faced of savings on all balance sheets, the region. public and private. To allocate savings efficiently to productive They also have the potential to fuel mainstay of support for the great investment, they will need broader economic development by reducing majority of elders. But over the next and deeper capital markets. To long-term fiscal burdens, by speeding few decades, all countries will need move their industries up the global the development of capital markets, robust floors of old-age income value-added scale, they will have and by helping to maintain adequate protection for the large share of to invest more in R&D, as Brazil is rates of savings and investment. workers who will arrive in old age now doing (with aircraft) and Chile Countries like Brazil that have large with an inadequate pension or no (with agribusiness). Above all, they pay-as-you-go public pension systems pension. Latin America is making will have to invest more—and more will need to increase their reliance progress here as well. Many countries, effectively—in human capital, the on funded retirement savings or including Brazil and Chile, now 44 ultimate resource of an aging society. face a zero-sum trade-off between provide some sort of basic pension Along with broadening access to a steeply rising contribution burden benefit to elders whether or not quality education for youth, this will on tomorrow’s workers or deep they have contributed to the formal mean retraining older cohorts of less reductions in benefits for tomorrow’s retirement system. Mexico, which skilled workers, who will dominate elderly. Countries that already have still lacks a floor of old-age income Latin America’s labor forces for savings-based public retirement protection, will need to put one in decades to come. systems in place will need to leverage place. The availability of these their benefits more fully. They will noncontributory benefits may to some Funded retirement systems have to exercise fiscal discipline during extent hamper efforts to encourage can help fuel development. the transition from pay-as-you-go to more workers to participate in funded in order to boost national contributory retirement systems. At the same time, Latin America savings. While maintaining strict But there are ways to mitigate the will need to build on its pioneering government oversight, they will also incentive problem by integrating the innovations in pension reform. We need to gradually liberalize investment two systems, as Chile has shown. In have argued that Latin America’s rules so that participants receive the any case, a broad and adequate floor funded personal accounts systems highest risk-adjusted returns. of old-age income protection is a confer important advantages in social necessity. confronting the aging challenge. As In the long run, as development populations age, they will be able to transforms Latin America’s labor If Latin America prepares for generate ample replacement rates for markets and participation in its formal its aging challenge, it will be retirees at far lower contribution rates retirement systems grows, funded positioned to assume a much than pay-as-you-go systems can. pension savings could become the larger role in world affairs. East Asia’s age waves dwarf Latin America’s. Elderly (Aged 65 & Over), as a Percent of the Population, 2005–2050 13

Elderly Share 2005 2050 40% Latin America 6.3% 18.5% China 7.7% 23.7% 35% East Asian Tigers 9.7% 34.9% n o i t

a 30% l u

p East Asian Tigers

o 25% P

e China h t

20%

f Latin America o

t

n 15% These global population shifts may e c r

e offer important opportunities for

P 10% Latin American countries. Skilled 5% labor will be in high demand in

0% developed economies with contracting 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 workforces. To the extent that Latin

Source: UN (2007) and CEPD (2008) American countries master the outsourceable skills in demand by global corporations, they will reap If Latin America prepares successfully stagnation in the developed world, the returns in higher wages and living for its aging challenge, it will not only as old-age dependency burdens soar 45 standards. Beyond the labor-market prosper as the twenty-first century and (except in the United States) synergies, there may be capital-market unfolds, but will also be positioned working-age populations enter a synergies. As economic growth begins to assume a much larger role in steep decline. East Asia, whose to slow in the developed world and world affairs. For much of its history, economic and geopolitical rise now East Asia in the 2010s and 2020s, Latin America has been what seems predestined, will confront a global savers will be looking for The Economist’s former Latin America massive age wave in the 2020s and investment opportunities in bureau chief Michael Reid calls the 2030s that dwarfs Latin America’s. fast-growing regions with stable “forgotten continent” and Foreign (See figure 13.) Tax burdens will governments, skilled workforces, and Policy editor Moisés Naim calls the rise, savings rates will fall, and today’s business friendly environments. By the “lost continent”—bypassed by the current account surpluses will 2020s and 2030s, many economists main currents of global economic evaporate. Russia and Eastern Europe, believe that the world will enter an and geopolitical events.36 Two or meanwhile, will be in the grips of an era of capital shortages. If so, Latin three decades from now, Latin unprecedented population implosion— America’s growing pension funds America could well be the with Russia plummeting from fourth could become a crucial source of “indispensable continent.” place in global population rankings in savings that helps fuel global growth. 1950 to twentieth place in 2050. Most of today’s dominant—and Latin America stands at a crossroads many of its emerging—economic Global population shifts where the paths forward lead in very powers are due to age both much are creating important different directions. Down one path sooner and much more than Latin economic opportunities lies the future where Latin America America will. The 2020s will likely be for Latin America. fails to leverage its demographic a decade of fiscal crisis and economic

36 Michael Reid, The Forgotten Continent: The Battle for Latin America’s Soul (New Haven, CT: Yale University Press, 2007); and Moisés Naím, “The Lost Continent,” Foreign Policy, no. 157 (November / December 2006). Unless growth accelerates, living standards 14 in most of Latin America will only rise slowly. GDP Per Capita in 2005 PPP Dollars, 2007 and Projections for 2030*

$30,000 GDP Per Capita, $28,068 as a Percent of Developed-World Average ✝ 2007 2030 $25,000 2007 2030

a Brazil 25.6% 24.2% t i

p $20,000 Mexico 33.8% 36.1% a Chile 37.1% 57.9% $17,492 C

r e

P $15,000

P $13,077

D $11,742 $11,929

G $10,000 $9,025 dividend. A generation from now in

2030, if historical growth rates $5,000 continue, living standards would barely have budged except in Chile. $0 Brazil Mexico Chile (See figure 14.) Growing old-age *Projections assume that labor-force participation rates by age and sex will remain unchanged and dependency burdens would leave that growth in real GDP per employed person will equal the 1975–2007 average in each country. †For the developed-world GDP projection, see The Graying of the Great Powers (CSIS, 2008). governments hard-pressed to maintain Source: World Bank (2008a); UN (2007); CSIS (2008); and CSIS calculations safety nets for the rising tide of indigent elders. With incomes growing workers migrate toward new skilled continental-sized economy, would slowly and the age of the average 46 jobs. The tax base would broaden, solidify its position as a global citizen steadily increasing, risk-taking, allowing societies to undertake economic power. Mexico would entrepreneurship, and mobility are ambitious new investments in doubtless maintain its close likely to decline. As people seek to national goals. Poverty would fall relationship with the United States, protect their economic and social and inequality, the hallmark of Latin but on entirely new terms—no longer privileges, inequalities in income and America since colonial times, would as a source of low-wage labor, but wealth could harden. While the mood steadily decline. The aging of Latin as a supplier of skilled workers and of youthful societies in the face of America’s populations would still perhaps even of scarce capital. adversity is often hope, the mood pose a serious challenge. But amidst of aging societies in similar growing and more equitably shared The whole world has a stake circumstances may be despair. affluence, it would be much in Latin America’s success. Then there is the path of higher more tractable. The whole world has a stake in growth and expanding opportunity. In this future, it would not only Latin America’s success. We are If all countries match Chile’s historical be Chile that enters the ranks of convinced that it will seize the growth performance, living standards high-income countries. Argentina, opportunity and prosper while it would double throughout Latin which in the 1920s had the world’s ages—thereby bettering not only America by 2030. If higher growth is fourth highest per capita income its own future, but the future of accompanied by effective reform of (just behind the United States, the rest of the world. business and labor-market regulations Canada, and New Zealand and just and large-scale investment in human ahead of the UK), would be rapidly capital, the size of informal sectors will regaining the ground it has lost. Brazil, shrink as tomorrow’s better educated with its enormous population and

A Note ondata Data and Sources and sources In researching and writing this Basic economic and development Commission for Latin America and report, CSIS consulted dozens data come from a variety of sources. the Caribbean’s CEPALSTAT database, of specialized studies on the Data on GDP, in both exchange rate which is available at implications of population aging for and purchasing power parity (PPP) http://www.eclac.org. Data on Latin America’s economies, societies, dollars, come from the World Bank’s current account balances and foreign and, of course, retirement systems. World Development Indicators (WDI) direct investment (FDI) come from This note makes no attempt to database and are available at standard international sources. 48 review this rich secondary literature. http://www.worldbank.org. Most Basic data on Latin America’s Its purpose is more limited—to orient labor-force and employment data funded pension systems, except for the reader toward the basic data come from the International Labor Brazil’s, come from the International sources used in preparing the report. Organization’s LABORSTA database Association of Latin American and are available at Most basic demographic data, Pension Fund Supervisors (AIOS) http://laborsta.ilo.org. The basic both historical and projected, are and are available at poverty measure (share of the from the United Nations Population http://www.aiosfp.org. These include population living on less than two Division and are published in number of contributors, real rates of dollars a day) and inequality measure World Population Prospects: return, administrative fees, portfolio (GINI coefficient) cited in the report The 2006 Revision (New York: UN allocation, and pension assets as a come from the World Bank’s WDI Population Division, 2007). These percent of GDP. Most of this data is database. Data on poverty rates by include total population, population also complied by the International age, however, come from Leonardo by age and sex, and most historical Federation of Pension Fund Gasparini et al, “Poverty among the data on fertility rates and life Managers (FIAP) and is available Elderly in Latin America and the expectancy. Unless otherwise noted, at http://www.fiap.cl. Caribbean,” CEDLAS Working Papers demographic projections refer to the no. 55 (La Plata: Center for For Brazil, we relied on a variety of UN’s most commonly used “medium Distributional, Labor, and Social sources. Most data on Brazil’s public variant” projection. The alternative Studies at the National University of pension system come from the long-term population projection for La Plata, July 2007). Basic fiscal data Brazilian Ministry of Social Brazil was made by CSIS using the come from the World Bank’s WDI Security (MPS), and in particular DemoTools cohort-component database and the UN Economic its Social Security Statistical Yearbook projection software package. nd sources (AEPS), which is available at among the elderly. To the extent pension recipients are from Fabio http://www.mpas.gov.br. Most data feasible, we included all public Giambiagi and Luiz de Mello, on Brazil’s private (“complementary”) pension schemes in our calculations. “Social Security Reform in Brazil: pension system come from “Brazil: The data for Chile, however, exclude Achievements and Remaining Programmatic Fiscal Reform Loan: the special regime for the armed Challenges,” OECD Economics Social Security Reform Project,” forces; the data for Mexico exclude Department Working Paper no. Implementation Completion and the PEMEX scheme and a few 534 (Paris: OECD, December 2006). 49 Results Report no. ICR717 other minor programs. For Argentina, data on the pay-as- (Washington, DC: The World Bank, you-go scheme, as well as data For personal account systems in December 19, 2007). Data on on recipients of noncontributory Argentina, Chile, and Mexico, we portfolio allocation, however, pensions, come from the National used data from AIOS and FIAP. come from the Brazilian Association Social Security Administration For other schemes, we used the of Pension Funds (ABRAPP) (ANSES) and the Secretariat of following sources. For Chile, data and are available at Social Security and are available at on the residual pay-as-you-go http://www.abrapp.org.br. http://www.anses.gov.ar and scheme, as well as data on recipients http://www.seguridadsocial.gov.ar, A special word is required about the of noncontributory pensions, come respectively. Data for other Latin active contributor rates and pension from the Chilean Social Security American countries come from Rafael receipt rates cited in the report. Agency (SUSESO) and are available at Rofman and Leonardo Lucchetti, Active contributor rates were calcu- http://www.suseso.cl. For Mexico, “Pension Systems in Latin America: lated as the ratio of contributors to data on the scheme for public-sector Concepts and Measurements of public pension schemes to the total workers come from the Public Coverage,” Social Protection labor force. Rates of pension receipt Workers’ Social Security Institute Discussion Paper no. 0616 were calculated as the ratio of (ISSSTE) and are available at (Washington, DC: The World recipients of old-age pensions http://www.issste.gob.mx. For Brazil, Bank, November 2006). from public pension schemes to data on contributors to public the population aged 65 and over. pension schemes come from Since the recipient figures include the Brazilian Ministry of Social pensioners under age 65, they Security and are available at somewhat overstate receipt rates http://www.mpas.gov.br; data on A Key to Chart Source Citations

ABRAPP (2008) = Consolidado IBGE (2007) = Complete Tables of Rofman and Lucchetti (2006) = Estatístico, Brazilian Association Mortality 2007, Brazilian Institute of Rafael Rofman and Leonardo of Pension Funds (ABRAPP), August Geography and Statistics (IBGE), Lucchetti, “Pension Systems in 2008, http://www.abrapp.org.br. December 2007, Latin America: Concepts and http://www.ibge.gov.br. Measurements of Coverage,” AIOS (2007) = Boletín Estadístico Social Protection Discussion Paper AIOS, no. 18, International INE (2008) = “46.8% of Chilean no. 0616 (Washington, DC: Association of Latin American Women Are Less Than 29 Years The World Bank, November 2006). Pension Fund Supervisors (AIOS), Old,” Press Release, National Institute December 2007, of Statistics (INE), March 7, 2008, UN (2007) = World Population 50 http://www.aiosfp.org. http://www.ine.cl. Prospects: The 2006 Revision, 2 volumes (New York: CEPD (2008) = Council for Minestério da Saúde (2008) = UN Population Division, 2007). Economic Planning and PNDS 2006: Pesquisa Nacional Development, Republic of China, de Demografia e Saúde da Criança U.S. Census Bureau (2008) = Population Projections for Taiwan e da Mulher (Brasilia: Brazilian International Data Base, Area: 2008–2056, August 29, 2008, Ministry of Health, 2008). U.S. Census Bureau, http://www.cepd.gov.tw//encotent/ http://www.census.gov/ipc/www/idb. MPS (2007a) = Brazilian Ministry m1.aspx?sNo=0001457. of Social Security (MPS), Base de World Economic Forum (2008) = CONAPO (2008) = Basic Dados Históricos do Anuário The Global Competitiveness Report Demographic Indicators, Estatístico da Previdência Social, 2008–2009 (Geneva: World Mexican National Population http://www3. Economic Forum, 2008). Council (CONAPO), dataprev.gov.br/infologo. World Bank (2008a) = World http://www.conapo.gob.mx. MPS (2007b) = Helmut Schwarzer, Development Indicators 2008, The CSIS (2008) = Richard Jackson and “Financiamento da Previdência World Bank, April 2008, Neil Howe, The Graying of the Great Social” (presentation at the 4th http://www.worldbank.org. Powers: Demography and Geopolitics meeting of the National Forum World Bank (2008b) = Doing in the 21st Century (Washington, DC: of Social Welfare, Brasilia, Business 2009 (Washington, DC: Center for Strategic and International April 24, 2007). The World Bank, September 2008). Studies, May 2008). Acknowledgments

The authors would like to insights about social, political and Musalem (Chief Economist, Center thank a number of individuals and economic trends in Latin America— for Financial Stability); Rafael Rofman organizations for their contributions and who also generously lent us (Lead Social Protection Specialist, to Latin America’s Aging Challenge: his talented interns, Alex Latin America and Caribbean Region, Demographics and Retirement Policy Demosthenes and Jorge Mora. We World Bank); Joaquín Vial Ruiz-Tagle in Brazil, Chile, and Mexico. also want to extend our thanks for (Chief Economist, Global Trends Unit, their excellent work to Gabriel BBVA); Helmut Schwarzer (Secretary First mention must go to Gabriela Arrisueño Fajardo, who translated of Social Security, Brazil); and Tapen Aparicio, who worked with the the report into Spanish, and to Sinha (Founder and Director, CSIS Global Aging Initiative as a Ximena Sierralta, who translated it International Center for Pension consultant on the project. She 51 into Portuguese. Research, ITAM). contributed her valuable insights at every stage of the research Along the way, the authors drew on While the authors gratefully and helped to shape the report’s the advice of many policy experts acknowledge the assistance they key arguments. A special note of who generously answered our many received in researching the report, appreciation also goes to Keisuke questions: Juan Luis Bour (Chief they are solely responsible for Nakashima, a research associate Economist, FIEL); Marcelo Abi-Ramia its content. with the CSIS Global Aging Initiative, Caetano (Economist, IPEA); Dirk for his indispensable help in pulling Jaspers-Faijer (Director, Population together the data and projections Division, ECLAC); Eduardo Fajnzylber that underpin our analysis. Without (Head of Research Department, their contributions, the report Superintendency of Pension Funds would be poorer. Administrators, Chile); Augusto Iglesias (Senior Partner, PrimAmérica); We would like to express our Estelle James (International Pension gratitude to Peter DeShazo, the Consultant); Daniel Kostzer director of the CSIS Americas (Coordinator for Social Development, Program, who shared his invaluable UNDP Argentina); Alberto R. About the Authors

Richard Jackson writes on Neil Howe is an economist, Rebecca Strauss is a research public policy issues arising from demographer, and historian who assistant with the CSIS Global the aging of America’s and the writes and speaks frequently on the Aging Initiative, where she conducts world’s population. He is currently aging of the population, long-term research on demography and a senior fellow at CSIS, where he fiscal policy, and generations in retirement policy. Her research directs the Global Aging Initiative, history. He is a senior associate interests include the impact of an adjunct fellow at the Hudson at CSIS, where he works with the population aging on the welfare Institute, and a senior adviser to Global Aging Initiative, a senior state, generational equity, and the the Concord Coalition. Jackson is policy adviser to the Blackstone social contract, as well as how the author or coauthor of numerous Group, and a senior adviser to demographic change affects social 52 studies on the implications of global the Concord Coalition. He is also mood and geopolitical stature. aging, including The Global founding partner and president of She is a coauthor of The Graying Retirement Crisis (2002), The Aging LifeCourse Associates, a marketing, of the Great Powers: Demography Vulnerability Index (2003), The HR, and strategic planning and Geopolitics in the 21st Century. Graying of the Middle Kingdom consultancy serving corporate, She has a B.A. in Honors Political (2004), Building Human Capital in government, and nonprofit clients. Science and History from an Aging Mexico (2005), The Aging Howe is the author or coauthor of Swarthmore College. of Korea (2007), and The Graying numerous policy studies and books, of the Great Powers: Demography including On Borrowed Time (1988), and Geopolitics in the 21st Century Generations (1991), 13th Gen (1993), (2008). Jackson regularly speaks The Fourth Turning (1997), and on long-term demographic and Millennials Rising (2000). He holds economic issues and is often quoted graduate degrees in history and in the press. He holds a B.A. in economics from Yale University. classics from SUNY at Albany and He lives in Great Falls, Virginia, with a Ph.D. in economic history from his wife Simona and two children, Yale University. He lives in Alexandria, Giorgia and Nathaniel. Virginia, with his wife Perrine and three children, Benjamin, Brian, and Penelope. About CSIS

The Center for Strategic and global development and economic Center for Strategic International Studies (CSIS) integration. Former U.S. senator and International Studies provides strategic insights and Sam Nunn became chairman of the 1800 K Street NW Suite 400 policy solutions to decision makers CSIS Board of Trustees in 1999, and Washington, DC 20006 in government, international John J. Hamre has led CSIS as its Tel: 202-887-0200 institutions, the private sector, president and chief executive officer and civil society. A bipartisan, since April 2000. www.csis.org nonprofit organization headquartered in Washington, DC, CSIS conducts research and analysis and develops The CSIS Global Aging Initiative 53 policy initiatives that look into (GAI) explores the fiscal, economic, the future and anticipate change. social, and geopolitical implications Founded in 1962 by David M. of population aging. CSIS established Abshire and Admiral Arleigh Burke, GAI in 1999 to raise awareness of at the height of the Cold War, CSIS the challenge and to encourage was dedicated to finding ways for timely reform. Over the past ten America to sustain its prominence years, GAI has pursued an ambitious and prosperity as a force for good educational agenda—undertaking in the world. Since 1962, CSIS has cutting-edge research projects, grown to become one of the world’s publishing high-profile reports, and preeminent international policy organizing international conferences institutions, with more than 220 in Beijing, Berlin, Brussels, Paris, full-time staff and a large network Seoul, Tokyo, Washington, and Zurich of affiliated scholars focused on that have brought together world defense and security, regional leaders to discuss common problems stability, and transnational challenges and explore common solutions. ranging from energy and climate to To learn more about GAI, visit its website at www.csis.org/gai.

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